Value and growth on scales

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Opportunities abound for value-seekers as world economies emerge from Covid restraints, says Lauren DeMore, assistant portfolio manager for Putnam Investments’ U.S. Large Cap Value Strategies.

DeMore said value typically outperforms growth coming out of a recession. This time around, value stocks are entering the strengthening market at their cheapest valuations in a long time — trading at a discount twice as big as it had been historically.

Furthermore, she said the value cycle, which emerged with vaccine-driven global optimism, will continue to ride value sector earning trends and expectations of rising inflation and interest rates.

“We think this value rally is sustainable,” she said.

The combination of increased savings, pent-up consumer demand, stores shelves that need replenishment, and pressure for businesses to resume capital expenditures have paved the way for value, she said.

“When you layer in a patient Fed, you have the ingredients for inflation and rising bond yields to continue. And the sectors that are most correlated with rising rates are the who’s who of the value benchmark. It’s banks, commodities, industrials,” she said.

On the earnings trend, she said value-oriented sectors like financials, energy and materials typically lead the market in improving earnings momentum.

“So, we think there’s still a supportive valuation environment for value over growth,” she said.


During the recovery period, DeMore has faith in banks, which had a rough run in 2020 and are currently trading at an uncharacteristically wide discount.

“That doesn’t really make sense to us. The banks are the barometer for the economy, so you’d think they’d participate in a market rally coming out of a recession,” she said.

Many of the headwinds they faced last year are easing or even reversing, and they’re beating earnings expectations by a wide margin. She expects buybacks this summer when restrictions on capital returns are lifted, and a return to credit growth in the second half of the year.

One of her favourites is Citigroup Inc., which has a consumer division that is likely to benefit from expected growth in personal borrowing.

“In terms of valuations, Citi trades at a wider discount to banks than it has historically. So, Citi is cheap, relative to the banks, which are cheap relative to the market,” she said.

The company’s new CEO Jane Fraser has announced the closing of a dozen consumer banking operations outside of the U.S., which were underperforming, and has begun transforming the corporate culture by discouraging after-hours work and putting an end to Friday Zoom calls.

“It sort of fits in the wheelhouse of what we like about banks right now, and there’s a turnaround story going on which value stocks really tend to like,” DeMore said.

Energy & materials

DeMore is also positive about energy.

“Our largest big-holding name is ConocoPhillips. They’ve had unwavering capital discipline over five years now,” DeMore said. That discipline allows the Houston, Tex.-based firm to cover their capital expenditures and pay dividends, she said, even with oil prices at US$40.

She added that ConocoPhillips is in a position to grow its dividend thanks to the firm’s acquisition last year of Concho Resources.

DeMore has also taken a significant position in San Antonio, Tex.-based Valero Energy Corp., and has smaller investments in Paris-based Total SE and London-based BP plc, pointing out that Europe seems poised to catch up in the energy stock rally after lagging the world in recent months.

She also expects materials to do well in the global recovery. Within that sector, her largest holding is Phoenix, Ariz.-based Freeport-McMoRan Inc., the largest copper miner in the world.

“They find themselves in the enviable position of having a ton of production coming online, right as copper prices are taking off,” she said. “The supply-and-demand dynamics for copper are really attractive.”

Relative value

DeMore likes Microsoft Corp., which she describes as a good example of her “relative value” approach despite its P/E ratio of about 30.

Microsoft’s three main businesses — software, cloud computing and video games — are well positioned against peers, she said. The company’s Office 365 subscription business rivals other software-as-a-service businesses like Adobe Inc. and Inc., both of which trade at much higher P/E ratios.

Microsoft’s Azure cloud business is a strong competitor to Amazon Web Services, while trading at a big discount to Inc.

And Microsoft trades at similar multiples to gaming companies like Activision Publishing Inc. (based in Santa Monica, Calif.) and Electronic Arts Inc. (Redwood City, Calif.).

“So, when we talk about relative value, what we often mean is relative to peers. And while Microsoft trades at a high multiple to the benchmark, it trades below peers on the sum-of-the-parts basis,” DeMore said.

Value traps

DeMore said the best defence against value traps is exhaustive research and analysis.

“The key is to remember that value or cheapness alone is not necessarily going to drive shares. What you really need to ask is, ‘Why are they cheap and when will that change?’” she said.

For example, tobacco giant Altria Group Inc. boasts an 8% dividend yield, underpinned by strong and steady cash flow of 10%. Currently trading at a 30% discount to historical averages, the stock may look like a bargain.

“But all they do is de-rate,” DeMore said. “So even with an 8% dividend yield, the total return for owning the shares over the past five years is 4%. And just to benchmark that, the return of the S&P over that period is 120%.”

Meanwhile, smoking is socially “off trend” and the industry faces stagnant revenues, heavy regulation and formidable ESG headwinds.

“Here is an example of a stock that is really cheap but for reasons that I have a hard time seeing changing,” she said. “It’s compelling. It has an 8% dividend yield. But if the stock goes down 10% every year, you don’t really make any money.”


This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.

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