Amid global tumult, U.S. "value" stocks seen safe

By Nick Olivari

NEW YORK (Reuters) – At the height of the Japanese nuclear crisis and the breakout of war in Libya in mid-March, the Standard & Poor’s 500 went negative for the year.

But U.S. value stock investors were buying. The reason? They always look for stocks with solid assets, especially when their prices fall.

In a year marked by frequent shocks, that strategy has worked for a sector that had faded in popularity. The Standard & Poor’s Value Index is up nearly 7 percent in the first quarter, compared with just below 5 percent for the Standard & Poor’s Growth Index, according to Reuters data.

“Buying something at a discount is always better than buying something on an aggressive growth assumption,” said Eric Cinnamond, manager of the Aston River Road Independent Value Fund for River Road Asset Management in Louisville. “I’m more of a ‘Steady Eddie’ manager. My clients don’t want excitement.”

The basic tenet of value investing is to overlook short-term factors depressing a stock and to study the assets — brand names, real estate, market positioning — that are enduring sources of cash generation.

When outside shocks hit, the same holds true. It takes nerve to accumulate value when things look hopeless and to refrain from buying when the market gets too rich.

Warren Buffett, reknowned professor of the value school, famously jumped in as a stock buyer at the depth of the global financial crisis in 2008. Again this year, when Japan’s radiation issues melted stock prices globally, he opened his checkbook. Buffett’s Berkshire Hathaway acquired Lubrizol for $9 billion on March 14 while stocks were falling. Berkshire is one of the components of the S&P Value index, along with names like big brand names like Johnson & Johnson and Wells Fargo.

Investors like Buffett don’t want to pay for overpriced growth opportunities, but instead, take advantage of stocks that the investing pack overlooks.

“Investors can misprice some companies so they fall into the value basket, making them too cheap for what they are.” says Lawrence Creatura, portfolio manager at Federated Clover Investment Advisors in Rochester, New York. “And that drives higher returns,”

A good market disruption helps create more of these opportunities.

LOOKING FOR CONSISTENT CASH FLOWS

So far in this year of volatile movement, Cinnamond’s fund is up 5.5 percent compared with the benchmark Russell 2000 small cap value indexes growth of 3.499 percent.

Cinnamond’s said his focus on cash-generating businesses has worked well in this sluggish economy. Looking at earnings growth alone could provide a narrow view of how companies perform.

“Cyclical growth is being confused with sustainable growth,” he said. “I like companies that are more steady, have no operating risk and consistent cash flows.”

Among Cinnamond’s top picks are Core Mark Holding Co Inc., a market leader in distributing goods to convenience stores, that that has managed 6.2 percent sales growth annually over the last 10 years. Another of his favorites, southern California grocery chain, Arden Group Inc., generates 3 to 4 percent growth in free cash flow.

“They have $17 a share in cash right now,” said Cinnamond.

STAYING CLOSE TO HOME

Taking it a step further, staying within the U.S.A. to buy value stocks helps minimize external shocks and currency risks.

Buffett became a Buy America advocate this year. His annual letter released late in February brimmed with references to the strength of the American people, economy and spirit.

“I will only buy U.S.-listed stocks,” said Brian Ferguson, senior portfolio manager, U.S. large-cap value at The Boston Company Asset Management LLC, who sees regulation and accounting rules as more predictable in the home market. Moreover, large-cap U.S. stocks derive 40 pct of earnings abroad and that alone gives global diversity.

He sees the financial sector as ripe for gains. It makes up 28.54 percent of the benchmark Russell 1000 value index, especially since the Federal Reserve this month lifted some dividend restrictions on banks given bailout funds.

Citigroup Inc., JPMorgan Chase & Co, and Wells Fargo & Co all responded.

More important than the payouts is the Fed’s overview on bank health, he said.

“Credit has been improving and is continuing to improve, balance sheets are improving, capital ratios, all are improving,” Ferguson said. Even after a big recovery, many of the stocks in the sector are far below their historic highs.

THE VALUE TRAP

Of course, some companies are cheap for a reason and will become even cheaper in the future. A trigger event is sometimes required to unleash the value.

“The key to avoiding this ‘value trap’ is to exhibit patience before investing,” said Federated Clover’s Creatura. “It’s important to have a catalyst approaching in the near term. Investors have to observe areas for the company’s situation to improve before employing capital.”

Two examples from his own list: Teen retailer Hot Topic Inc., has appointed a new chief executive, lifting its stock price 2.5 pct the day it was announced. Another, K-Swiss Inc, recently allocated enough cash to reinvigorate their sneaker line and should benefit from the back-to-school retail market.

Creatura’s $200 million Federated Clover Small Value Fund is up 3.56 percent year to date compared with the Russell 2000 small cap value’s 3.499 percent.

(Editing by Richard Satran and Bernadette Baum)

Amid global tumult, U.S. "value" stocks seen safe