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The Best Sectors for Value Stocks

May 31, 2017, 11:05 am

As value investors we tend to look at potential market obstacles more realistically than growth investors, with a more discerning eye toward risk. This, along with the decline in interest rates this year that favors growth stocks, has led to a gap in performance between the two categories. This year has reversed an extended period where value stocks have outperformed, but even with this year’s strong tilt toward growth, average annual returns over the past five years between the two indexes have been relatively even.

All that said, now remains a great time to be invested in value stocks. If the economic growth needed to sustain the bull market continues, we will almost surely see a rise in rates – perhaps a significant one from the current depressed levels – which will put value stocks even more in favor.

Plus, the current divergence in performance is creating plenty of opportunities in value names, and there are several sectors (and stocks within them) that could be good investments down the road. For today’s blog, I’d like to share the three sectors I am most interested in for value plays with you.

Financials are down more than 8% from their highs in early March. However, as economic growth continues and interest rates rise, they are likely to become the market leaders. When the tide begins to turn in favor of the banks again, Goldman Sachs (GS) and Citigroup (C) could be possible plays here, as both still trade at relatively low levels of price to book value.

Quality materials stocks have also been left behind, and two I am considering are specialty steel maker Nucor (NUE) and Domtar (UFS). NUE had strong first-quarter earnings of $1.11 a share (versus $0.27 a share last year), but because the company narrowly missed estimates, the stock is nearly 10% off its pre-earnings levels and 15% below its highs of last year. NUE trades at 14X this year’s earnings estimates, which is cheap but not extraordinarily inexpensive, so I’d like to see it dip further to the low $50s.

UFS is feeling earnings pressure due to higher raw material costs, and EPS for the year is expected to decline from $2.97 to $2.84. However, the stock becomes very attractive once it hits $34, and the 4.5% dividend yield should also support the shares.

And lastly, there has been no group more beaten down than the automakers. While they have enjoyed strong sales for several years, shareholders have little to show for it. I believe General Motors (GM) and Ford Motor (F) are too risky considering how much cash they burn through during a recession and the cash drain they also face from their pension and post-retirement benefit plans. However, if auto sales can remain stable at high levels, giant auto retailer AutoNation (AN) is worth considering. The stock is trading at a 10-year low and close to 10X expected 2017 earnings. The company grew nicely during the auto boom, aided by an acquisition, and is strongly entrenched as a leader in auto retailing for years to come.

These companies tend to do the best when the economy is strong, so I’ll need to see more evidence that we can get to 3% GDP growth and/or that the current slump in auto sales is coming to an end before making a move on any of them. Under the right circumstances, automakers have strong upside potential, but they must be bought at the right price and in the right economic environment. And in the current market, discipline is very important.

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