In Search of Value Stocks? Try Beverages and Healthcare

by: FP Trading Desk

Value-oriented managers spend a lot of time trying to discern the true “dogs” – those stocks that may not benefit from the next cycle – from names that are simply out of favor but will rebound. What they are foremost trying to avoid is value traps – stocks that have experienced a large price declines and are mistaken to be value names.

In contrast with 2008, where quantitative strategists at Bank of America Merrill Lynch (NYSE:BAC) saw value trap candidates triple as the market itself looked like a giant value trap, they see far more attractive value opportunities today.

But where are these opportunities found? In industries that appear to be undervalued relative to their own historical average market multiple, but where fundamentals are improving faster than prices are responding on the upside. Industries with these characteristics have outperformed the benchmark by 5.9% during the past decade and returned 9.8% in February.

The strategists said an overwhelming majority of industries identified as opportunities are in the classic defensive sectors of staples (eg. beverages) and health care (eg. biotechnology and pharmaceuticals).

In February, the discretionary sub-sector of diversified consumer services joined the list of industries that screen well in terms of valuation, momentum and revisions. In staples, personal products and food products made the cut, as did software, which falls under the technology group.

The strategists said in a research note:

Our work suggests that the hardest thing for a value manager to do is to buy a stock, and good value-oriented managers are likely to be buying stocks later than their peers. Value managers often like to say that they will buy stocks early but they’ll be there at the bottom. Although that sounds encouraging, the route to value fund underperformance is to buy early too many times.