Value Stocks Could Be Cheap for a Reason

Many investors are—sensibly—considering rebalancing their portfolios away from the large-cap tech and growth stocks that have driven market performance. The search is on for strategies that may potentially lead the next leg of a rally. Value stocks are one example, as they tend to trade at lower prices relative to their fundamentals. While value stocks are indeed less expensive, they may represent a “value trap”—cheap for a reason. As a group, the companies in the S&P 500 Dividend Aristocrats Index offer a compelling alternative of historically attractive valuation, higher quality—as measured by credit ratings, price/earnings (P/E) ratios and return on assets (ROA)—resiliency, better total return and higher historical dividend growth.

Definitions: Price/earnings (P/E) ratio shows how much investors are paying for a dollar of a company’s earnings. Return on assets (ROA) indicates how efficiently a company utilizes its assets, by determining how profitable a company is relative to its total assets.

Large-Cap Tech and Growth Stocks: Some Considerations

What’s not to love about large-cap tech and growth stocks? The tech sector accounts for nearly 40% of the market-cap weighted S&P 500 Growth Index. If you include Facebook, Google and Amazon, that figure rises to more than 55%.

Shouldn’t these companies be driving the market? The pandemic alignment is clear: Working from home, e-commerce, cloud computing and other transformative business changes have helped buoy technology-related companies. Low interest rates help, too. In fact, low interest rates disproportionately help growth stocks by increasing the value of big cash flows out into the future. The fear of missing out—or more formally, “momentum”—has also supported tech stocks. If fundamentals are important to you, note that, as opposed to 20 years ago, most of these high-flying tech companies are highly profitable. So what’s the problem?

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