Take your time to search for some hidden value stocks
Published May 08, 2023 • Last updated May 08, 2023 • 3 minute read
Traders work on the floor of the New York Stock Exchange. Photo by Michael M. Santiago/Getty Images files Springtime is typically when you change up your wardrobe to match the weather, which can be a rather expensive exercise, but my teenage sons have thankfully decided to join the latest trend among young people these days: thrifting.
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Access articles from across Canada with one account. Share your thoughts and join the conversation in the comments. Enjoy additional articles per month. Get email updates from your favourite authors. The great thing about thrifting is that it can be a low-cost way to get ready for a new season by donating clothes you no longer wear and buying replacements from others who have done the same. There are times when the kids find nothing of interest and other days when they buy some real gems, such as name-brand jeans or hoodies, for only a few dollars. To help maximize their success, they have even gone so far as identifying when their favourite thrift stores usually restock their inventory.
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The same can be done with your investment portfolio, especially if you’re looking to make an adjustment to match a changing market environment. You can either rush to buy the latest trendy stocks at a premium or take your time to search for some hidden value.
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Article content In today’s market, we think the former strategy means paying full retail price for large megacaps such as Apple Inc. and Microsoft Corp. There is nothing wrong with these companies, as their recent quarters have shown, and you can’t blame investors for buying them, especially if recency bias plays out.
Stripping out these megacap stocks, the S&P 500’s annualized performance over the five years to the end of February 2022 would have been cut by 54 per cent to 6.98 per cent from 15.17 per cent, according to YCharts Inc. and a recent white paper, The Real Impact of Mega Cap Stocks on Your Portfolio & The Market.
That said, the thrifters out there might want to sell some of their holdings that are trading near record-high multiples and start hunting for some value. For those wondering where to look, we think one such area could be the small-cap space.
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Article content Not surprisingly, investors have been herding into the perceived safety of the megacaps over recession fears and concurrently selling small caps. The MSCI World Small Cap index is now trading at a 20-year low of 11.9 times earnings, which is nearly half of its 2020 high of 20 times, according to asset manager Pzena Investment Management LLC and highlighted in MarketWatch.
However, prior evidence suggests you should be doing the opposite if you believe we are indeed in a recession. Investing in small caps during recessions has generated investment returns that were as much as double those of large caps, according to a February 2023 study by Schroders PLC that looked at data back to 1980.
Penza research has also indicated that small-cap stocks have outperformed large-cap equivalents since 1975 by more than 100 basis points per year, with small-cap value doing even better, with an annual 300 basis points of superior performance.
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Article content Perhaps this is because, like thrifting, these companies are underfollowed by stock analysts and, therefore, there is a lot of potential to find hidden gems compared to the megacaps that are heavily tracked by Wall Street.
Another area investors may want to look at is the value segment of the market. As of April 27, 2023, value stocks are trading at 14.13 times earnings, in-line with their long-term average since 1997 of 14.09 times, according to J.P. Morgan Asset Management Inc.
Market offers yardstick for looking at private assets like real estate Confusing market information means it’s better to go your own way Three ways to become a happier investor By comparison, growth stocks are currently trading at 23.6 times earnings, or nearly 14 per cent above their 20.77x average over the same period. On a ratio basis, value is currently trading at only 0.6 times that of growth, well below its long-term average of 0.71 times.
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Now, we’re not saying investors need to go all in on these two segments of the market, but if you’re looking to change things up a bit, maybe it’s a good time to learn from all those teenagers and diversify your portfolio’s wardrobe by adding some of these low-cost, and potentially attractive, items. That’s a value village you may want to visit every once in a while.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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