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WALL STREET, CALIFORNIA | MUTUAL FUNDS

Value Stocks May Offer Safer Haven in Turbulent Market

September 22, 1998|PAUL J. LIM

Times of market turmoil are supposed to be times when Wall Street seeks shelter in so-called value stocks--overlooked or otherwise unloved stocks that are relatively cheap when compared with the average stock.

And in this year's market pullback, value-oriented mutual funds have, in fact, turned out to be somewhat safer havens than their growth stock fund cousins.

Whether that will continue is an open question, but after five years in which value stocks have mostly taken a back seat to growth stocks such as richly valued Microsoft and drug giant Pfizer--many value fund managers believe their day should be here.

"It's overdue," said Jean-Marie Eveillard, the value-oriented manager of SoGen International Fund. "It's long overdue."

Just what is a "value" stock? Wall Street usually categorizes value and growth stocks according to two key measures:

* The price-to-earnings ratio (P/E), which is the stock's price divided by the company's most recent four quarters' earnings per share, and

* The price-to-book-value ratio (P/B), which is the stock's price divided by the company's net asset value per share--that is, the value of the assets minus the company's liabilities.

In theory, the lower a stock's P/E and P/B, the lower the risk an investor takes in owning the shares. Hence, the value label.

And in the market decline so far this year, value stock mutual funds have turned out to be lower-risk holdings than growth stock funds, at least on average:

According to mutual fund tracker Morningstar Inc. in Chicago, the average large-cap value fund has fallen 14% since blue-chip shares peaked July 17.

By contrast, the average large-cap growth fund has fallen 16.6%.

The same divergence holds true for small-stock funds, Morningstar figures show.

The average small-cap value fund has fallen 25.4% since the Russell 2,000 small-stock index peaked April 21.

The average small-cap growth fund, meanwhile, has lost 27.5%.

(All of these figures are total returns, which is price change plus dividends.)

This seems to prove Jim Stratton, president of Stratton Capital Management in Plymouth Meeting, Pa., correct.

Notes Stratton: "Value managers tend to underperform in strong up markets and outperform in down markets."

Still, value funds are trailing growth funds badly for the year-to-date.

The average large-cap value fund is down 2.6% for the year, and the average large-cap growth fund is ahead 6.9%.

And that has been the story for most of the 1990s.

Some analysts argue that value will remain in the doghouse.

Richard Bernstein, market analyst at Merrill Lynch, argues that because corporate profit growth is slowing overall, many investors will be wary of value stocks.

Why?

In times of uncertainty, many investors flock to quality--that is to say, they favor strong companies with proven track records.

Notes Kim Goodwin, manager of the American Century-Twentieth Century Growth Fund: "In times when earnings are hard to come by [such as now], investors are willing to pay a premium for companies that deliver consistent, predictable earnings growth."

And that favors the fortunes of growth stocks and thus growth funds, she argues.

It's difficult to say whether this sentiment still prevails, or whether investor psychology has changed.

"Maybe investors are beginning to realize that if we're going to be in a difficult or bearish market for some time, value exposes [them] to less risk than growth or momentum investing," said Eveillard.

Exposure to Both Growth and Value

Regardless, Robert Boyd, manager of the UAM ICM Equity value fund, notes that there's something else working in favor of value managers these days.

The recent market correction has put many of the S&P 500's top stocks on sale--stocks that value managers could not touch as recently as a month ago.

Notes Boyd: "We haven't felt this comfortable buying stocks since the fourth quarter of 1994."

The argument for value investing now seems strongest within the small-cap universe.

Even if value funds aren't poised to rally right now, Luke Collins, director of KPMG Peat Marwick's investment consulting practice, argues that it still "makes sense to invest in value."

Indeed, take away the last year, and value stocks, going back to Dec. 31, 1974, have actually beaten growth stocks, delivering annualized returns of 17.7% versus 15.3%.

Over the last 15 years, the average value fund that invests in large companies such as Ford Motor Co., which trades at just 2.4 times the company's earnings per share, has delivered almost exactly the same returns as the typical growth fund--and with decidedly less volatility.

Rather than try to time the market periods in which either growth or value is ahead of the pack, financial planners argue that investors should be exposed to both value and growth stocks at all times.

The simplest way to ensure that your portfolio has exposure to both growth and value stocks is through an index fund, financial planners say.

Yet investors may want to manage this mix themselves. Why?

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