The Biggest Reason to Invest in Value Stocks Now

Steve's note: While I urge you to be invested now, it's smart to prepare your wealth for what comes next. My colleagues Dan Ferris and Mike Barrett believe a change is coming for the markets – and long-overlooked value stocks could surge as a result. But even now, in the late innings of the Melt Up, Mike says these normally slow movers are setting up for big gains...


Value is overtaking growth...

Yesterday, I showed you why it's happening. Earnings growth has been slowing down...

Out of the 113 S&P 500 Index members that issued earnings-per-share ("EPS") guidance for the quarter ending September 30, 73% have lowered their previous expectations. That's slightly above the five-year average of 70%, according to market-data firm FactSet.

But whether earnings growth continues to decline or reaccelerates, value stocks are still likely to outperform growth stocks going forward.

And that means the investors who have been patiently waiting for this day are about to get a glut of lucrative opportunities – starting now.

Let me explain...

Based on its analysis of previous cycles, Bank of America Merrill Lynch believes U.S. stocks could surprise to the upside after bottoming later this year. That's because the investment bank forecasts that corporate earnings will reaccelerate into 2020.

But if that were to happen, it would actually create an even better reason to rotate into value stocks.

Savita Subramanian, Bank of America Merrill Lynch's head of U.S. equity and quantitative strategy, says that times of reacceleration are when value typically outperforms growth.

If you look back a couple of years, you'll see a great example...

Back then, investors became giddy about the promise of e-commerce – and Amazon, in particular. In turn, they gave up on retailers with business models heavily tied to its primary target: U.S. shopping malls.

Abercrombie & Fitch (ANF) was among the victims... From 2011 to 2017, the company's stock plunged from roughly $75 per share down to a 17-year low near $9 per share.

Investors believed this iconic apparel retailer couldn't survive in the era of e-commerce. But they were wrong...

As you can see in the following table, Abercrombie's EPS gradually improved over the next three quarters. And as that happened, the company's price-to-sales (P/S) ratio more than doubled...

The combination of accelerating EPS and a sharply higher valuation translated into a soaring share price... In just nine months, Abercrombie's stock jumped 211%. That performance trounced the S&P 500 at 7% and the growth-focused Vanguard Mega Cap Growth Fund (MGK) at 13%, over the same period.

In short, Abercrombie – a so-so business that most investors had left for dead – strongly outperformed almost every other stock (including many high-quality ones) as earnings growth accelerated and investors sharply adjusted their valuation of those earnings upward.

Now, no one can say for sure if earnings will accelerate into 2020 or not... But it could certainly happen if interest rates stay low and we see a sudden resolution to the trade standoff between the U.S. and China.

The big reason value stocks will outperform in this scenario is because of valuation differences...

The market's most neglected stocks have plenty of room to re-rate much higher if EPS growth turns higher. That isn't the case with many growth stocks, whose valuations have remained persistently high for the better part of the past decade.

In his classic book The Most Important Thing, legendary investor Howard Marks urges investors to chart a different course if they want to outperform the market...

The key is who likes the investment now and who doesn't... The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price, can only go one way: up.

In Extreme Value, editor Dan Ferris and I have embraced this thinking with our first three "Golden Age of Value" picks...

Each company is a leader in its respective industry. But despite expectations of an earnings acceleration into 2020 and 2021, all three trade at low relative valuations.

All three companies also pay dividends. (One currently yields almost 6%.) And highly experienced management teams run all three companies. These folks know how to survive economic downturns... and then thrive afterward.

One of these recommendations is also likely to create additional value for its shareholders by spinning off one or more market-leading divisions in the future.

And as I said yesterday, we just heard the starting gun for the Golden Age of Value. So we're just beginning...

Dan and I will be on the lookout for other great companies to add to our Extreme Value model portfolio in the coming months. I encourage you to come along for the ride...

Good investing,

Mike Barrett

Editor's note: Mike and Dan just released an urgent presentation on the Golden Age of Value, starting with an event that rocked the market last month. If they're right, we're about to see a huge shift of investing capital... And to come out ahead, it's likely you'll need to completely change your investing playbook. That's why they're pounding the table on these three recommendations today... Click here for more details.

Further Reading

Catch up on Mike's essay in yesterday's DailyWealth about slowing earnings growth right here: The Starting Gun Just Fired.

"You expect the good times to last far longer than you should," Dan writes. "But that sort of thinking can get you into trouble in the markets." To avoid this problem, investors need to answer one question before putting money to work... Learn more here.

Market Notes
MAKING STEADY INCOME WITH THIS REAL ESTATE STOCK

Today, we’re looking at a business model that rewards shareholders with steady income…

Real estate investment trusts (“REITs”) are companies that rent out real estate. They allow investors to “become landlords” without having to deal with the headaches of owning property… like maintenance problems and collecting rent. Best of all, REITs must pay at least 90% of their income back to shareholders as dividends. And today’s company is thriving on this unique business model…

Realty Income (O) brands itself as “The Monthly Dividend Company”… and with good reason. The company has paid 590 consecutive monthly dividends over its 50-year history. And it just announced its 103rd monthly dividend increase. The company owns more than 5,900 real estate properties, with top-earning tenants like Dollar General (DG) and Walmart (WMT)… So that monthly dividend shouldn’t stop anytime soon.

As you can see, O shares have returned nearly 40% in the past year alone, including dividends… And they just hit a fresh all-time high. Investors looking for consistent income should make sure to check out this business model…