7 reasons investors should favor value stocks over growth, according to BofA
- While most investors likely view the latest rotation into value
stocksto be temporary, Bank of America sees "more room to run" for the rotation.
- Bank of America suggests investors focus on buying high-quality value stocks, and in recent notes said value investors should incorporate intangible assets, like company patents and branding, into their analysis.
- Here are seven reasons why investors should favor value stocks over growth stocks, according to BofA.
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Value stocks in September have finally shown signs of beating their growth peers, amid a
While most rotations into value and out of growth have been short-lived over the past decade, Bank of America sees "more room to run," according to a note published on Tuesday.
Mostly, it's the economy. A recovering economy should favor cyclical stocks, which tend to fall in the value category.
But investors shouldn't blindly buy value stocks based on just a low price-earnings ratio. That can often lead investors into buying "value traps," stocks that look cheap but in reality are cheap for a reason.
Instead, investors should focus on high-quality value stocks — those that may have low price-earnings ratios, but also sport high returns on equity. Additionally, BofA has argued in recent weeks that value investors should incorporate intangible assets (patents, brands, intellectual property, etc.) into their valuation analysis.
Here are seven reasons why value stocks are set to outperform growth, according to BofA.
1. "It's the economy."
"Value outperformed the S&P 500 for at least 3 months around the nadir of every economic recession we have had in the US since 1929. And Value outperformed by about ~12ppt on average during its first three months of relative leadership," BofA said.
2. "Style cycles are driven by profits, not rates."
"When growth is scarce, investors will pay up for growth. As growth broadens out, investors become more price sensitive and seek out the cheapest growth they can find. Contrary to popular belief, rates have very little impact on style rotations."
"Active managers maintain a near-record over weight in Growth sectors like TMT and a near record underweight in Value sectors like Financials. FANG carries an overweight of 1.7x by hedge funds, and 1.8x by long only mutual funds. Banks are at a post-GFC record underweight. On almost any measure, and among almost every investor group, Growth is over-owned and Value is neglected," BofA said.
4. "Value is undervalued."
"Value sits close to the deepest discount to Momentum. The only other instances during which Value traded at such a steep discount were 2003 and 2008, after which Value outperformed Momentum by 22ppt and 69ppt, respectively, over the subsequent 12 months," BofA noted.
5. "Abundance of mean-reversion alpha."
"As Growth has grown pricier and Value has grown cheaper, valuation dispersion has risen to the highest levels since the GFC. When valuation dispersion has been this high or higher, Value stocks have outperformed Growth 95% of the time over the subsequent 12 months, by 24ppt on average," BofA said.
6. "Anti-monopolistic risks to growth stocks."
"As victims of 'peak plutonomy' more forcefully express their views at the polls, the implications for oligopolies are greater regulation/taxes, lower PEs/profits growth and an eventual break up of some oligopolies. The 'haves' are generally growth stocks, whereas the 'have-nots' tend to be old economy Value stocks," said BofA.
7. "Japanification favors value."
"We don't think it will for a host of reasons (culture of immigrants, higher nominal GDP, more active shareholders, etc.) but similarities (low rates, aging demographics, a closing economy, deflationary threats and a range-bound market) are hard to ignore. Japan factor performance during the 1990s' 'Lost Decade' indicates that Value was the best performing factor among the standard quantitative strategies," BofA explained.
Read more: 'We are going to see some big shifts in the coming 3 to 6 months': Investing pioneer Rob Arnott sounds the alarm on 'quite a few bubbles' in the market, including the tech boom - and tells us where he is finding bargains now
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