Sunday, October 30

Week 17 - Value vs. Growth

Situation: ITR investors need to know the broad outline of a company’s business plan, so they will not be surprised by price swings in bull and bear markets.

Goal: Orient ITR investors to important accounting ratios that will help them characterize a stock.

To some extent, all of the stocks that are covered in ITR blogs can be called “value” stocks because the companies pay dividends, and those dividends are bigger than the market yield. Growth stocks produce a total return mainly through price appreciation, whereas, value stocks produce a total return mainly through sizable dividend payouts. 

Growth companies tend to be priced high relative to earnings and book value, and the total (enterprise) value of the company tends to be high relative to operating earnings (EBITDA) and sales (Revenue). The updated Master List (Week 16) has a column for each of these 4 accounting ratios. Higher ratios represent stock prices that have been “bid up” in expectation of continued growth for both the price of that stock and the economy. That is speculation, whereas, the payment of a dividend is real.

Growth companies like Colgate-Palmolive (CL), Coca-Cola (KO), McCormick (MKC), Automatic Data Processing (ADP), and T. Rowe Price (TROW) pay a modest dividend and have 3-4 elevated accounting ratios. At the opposite end of the spectrum are value companies that pay a substantial dividend and have 0-1 elevated accounting ratios: Sysco (SYY), Pepsico (PEP), Kimberly-Clark (KMB), NextEra Energy (NEE), and Chevron (CVX). “Defensive” industries (utilities, health-care, consumer staples) are the usual source of value stocks. However, you’ll notice that here we have an energy stock (CVX) but no health-care stock. (ABT and JNJ yield over 3% but aren’t cheap.) NEE is partly an energy stock, since only half is a regulated utility (Florida Power & Light); the other half is a wholesaler of wind & solar electricity (NextEra Energy Resources). The fact that NEE and CVX are value stocks tells us that energy production & distribution can be purchased very reasonably. On the other hand, pharmaceutical companies, are unreasonably expensive. Both conditions are likely to reverse because energy companies will be able to raise prices as the economy recovers, whereas, pharmaceutical companies will be constrained by the Affordable Care Act.  

Bottom Line: When the economy recovers, value stocks won’t have much lost ground to recover.

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