Investors have been buying stocks on the cheap since the dawn of the stock market, presumably under the belief that eventually those unpopular stocks will have their day in the sun. But value investing can still succeed even if the sentiment around those cheap stocks stays unchanged, contends an article in Morningstar by John Rekenthaler.
To understand why, Rekenthaler highlights what happens when a bond declines in price so much that it becomes a value bond. An investor who sinks $20,000 into the sub-par bond will receive more lots for his money, and earn a higher annual payment than an investor who puts the same amount of money in a bond that’s trading at par. If the bond issuer burnishes its reputation, so much the better for the investor, but even if they don’t, that investor is still the winner. Of course, stocks are different than bonds, and their payouts carry much more uncertainty. But many stocks—85% of the S&P 500—do pay dividends and the same principle as the bond example above holds true. The value investor is able to buy more shares and therefore earn a bigger dividend payout than a traditional investor, the article maintains.
Even though some stocks don’t pay dividends, almost all stocks eventually will if they live long enough. However, stocks have variable payouts, so investors must be sure that the security on the stock is “money good” and that the issuer will fulfill its obligations even if there are concerns about the company. And of course, there’s always the possibility that a higher-priced stock will skyrocket, with its payouts increasing so much that it outpaces the payouts of the value stock. A value investor has to be prepared for long dry spells and to be outshone by growth stocks, particularly large-cap tech companies. Indeed, thanks to massive profits that exceeded even the most optimistic expectations, growth stocks have pummeled their value counterparts for the last five years, according to Morningstar data. In that case, value investors were wrong while growth buyers were right. But it’s also entirely possible that expectations stay steady, keeping both growth and value on level ground, and in that scenario value investing would come out a real winner.
