Savvy shoppers make savvy investors
Reprinted courtesy of MarketWatch.com
Published: Feb. 13, 2013
To read the original article click here
If you’re a good shopper, you know one of the keys to being a good retirement investor: Look for good values. A savvy shopper knows how to spot value. A savvy investor owns value stocks.
This is a simple concept that really works. If you want better long-term returns (and who doesn’t?), you can get them by using value funds to buy assets that are “on sale.“ This is sometimes uncomfortable, because it can mean owning stocks whose prices have been going down instead of up. But the payoff can be great.
It’s a pity more investors don’t behave like good shoppers. If they did, they would look for opportunities to buy assets that are on sale. The good news is that lots of these bargains are always on sale and easy to buy through value funds.
As you probably know, popular growth stocks have many fine attributes and command premium prices. Google GOOG, -0.10% is a well-known example of a growth stock. By contrast, value stocks are sometimes viewed as “dogs.“ They may suffer from bad products, mediocre management or fierce competition. Sometimes their biggest shortcoming is nothing but a lack of glamour—which can lead many investors to look elsewhere.
But no matter the reason, over the long haul value stocks (when they are owned by the hundreds in value funds) have a history of paying more than growth stocks. That’s why savvy investors own them, and you should too.
‘Value’ consistently beats ‘growth’
The evidence for this is not hard to find.
In my book “Live It Up Without Outliving Your Money,” I show the results of an 82-year study of value stocks vs. growth stocks. In every single 20-year period during that time, value stocks outperformed growth stocks, with an average return premium of 5.4 percentage points.
Value beat growth in 89% of the 10-year periods (average premium: five percentage points of annual return), in 82% of the five-year periods (average premium: 4.9 percentage points), and in 65% of the one-year periods (average premium: 5.5 percentage points).
Here’s what that means to you: Based on this long history, if you own U.S. value stocks for at least a year you have nearly a two-thirds chance that you’ll beat growth stocks. Savvy investors like having odds like those on their side.
But wait. It gets even better.
The figures I just cited were for large-cap stocks. Does value investing work the same way among smaller companies? You bet it does!
Over the past 50 years, small-cap value stocks returned 15% annually, vs. 8.4% for small-cap growth stocks.
So, you might wonder: Why don’t all investors jump on this well-documented bandwagon and cash in? Why is it so hard for investors to see the value in value stocks?
I think the answer is partly rational and partly emotional.
Rationally, when you examine a specific company it’s easy to recognize the high risk of things that can go wrong. No savvy shopper would snap up a product that looked as if it were likely to fall apart quickly. How many investors are eager to snap up shares of a company with obsolete products in a dying industry? Not many!
However, value stocks typically are likely to return to favor for various reasons. And when they are owned by the hundreds (through mutual funds or ETFs) they are much less risky.
Still, investors want to feel good, and they usually feel good when they own “winners,“ especially ones that are being touted by Wall Street and the financial media. Value stocks are, almost by definition, not obvious winners.
Here’s where the savvy-shopper mentality comes in: If you’re looking for long-term results above those you would get from following the crowd, you’re likely to find those results from owning value stocks.
True for international stocks, too
The value in value funds isn’t limited to U.S. stocks. In fact, the statistical case is even stronger among international stocks. From 1975 through 2012, international large-cap growth stocks returned 8.7%; international large-cap value stocks returned 14.9%.
Many investors still have trouble with value stocks, especially when they look at them one by one. Based on history, I’m confident in predicting that more than half of the stocks that are out of favor today will still be out of favor five years from now, in 2018.
And yet I find it interesting how few value stocks it takes to produce their higher returns as a group.
In fact, all it takes is a minority of these companies to return to investors’ favor in order to lift the performance of the entire group.
There is no way to know which of today’s value stocks will become tomorrow’s winners. Fortunately, you don’t have to know that if you buy the whole asset class through an index fund or an ETF.
That’s what savvy investors do.
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Richard Buck contributed to this report.
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