This WSJ story is a reminder of the need to be critical about what you read. It cites COMPAQ as a growth stock which fell sharply because it's valuation measured by its p/e ratio was too high!
Special Reports April 16, 1999
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A New Breed of Value Funds
Is Looking to Riskier Issues
By PUI-WING TAM and PATRICK MCGEEHAN
Staff Reporters of THE WALL STREET JOURNAL
Forgive investors in "value"-stock mutual funds if right now they feel like throwing their underperforming portfolios out the window.
These seemingly quaint funds, which generally search for overlooked bargains among stocks, have been trounced of late. They're in the red for the past 12 months -- down an average of more than 6% -- even as the overall market has been going gangbusters.
Some value!
In particular, diamond-in-the-rough mutual funds have been left in the dust by funds that focus on large growth stocks -- and, of course, those scooping up freshly minted Internet stocks. And it gets worse: While value funds have historically been touted as a less-volatile category than growth funds, the big growth stocks actually held up better than the big value stocks this past August, when a spreading global financial crisis knocked U.S. stock markets for a loop.
But as painful as all this is to swallow, it isn't simple deciding what to do. Indeed, with signs this week of a shift in investor sentiment toward older, industrial companies -- standard fare in many value funds -- and away from some of the year's biggest growth stocks in the technology sector, the big question is whether value funds are about to come back into vogue.
And, if so, which breed of value fund makes more sense, the traditional type that stick to stocks that are indisputably cheap, or a newer breed that takes chances on pricier stocks in hot sectors?
The choices range from the soon-to-reopen Vanguard Windsor Fund, a portfolio with returns so disappointing last year that Vanguard Group is now shaking up its management structure, to the likes of turbocharged Legg Mason Value Trust Primary Class, whose manager, William Miller, has built a portfolio that looks to many suspiciously like a growth fund. Keeping up with the go-go market has been so difficult that other value-fund managers have followed Mr. Miller's lead into technology stocks, a volatile sector that value managers historically have avoided.
For his part, Mr. Miller argues that holding shares of America Online, Dell Computer and Gateway isn't inconsistent with a value approach. "Technology just happens to be where we think the greatest valuation anomalies can be found," he says. "I don't claim that AOL is now or has been a 'value stock.' That's different from saying it has good value." His fund is up more than 20% so far this year.
However it is defined, value is due for a rebound, says John Bogle, Vanguard's senior chairman and founder. "I don't know when it will happen, but last year was the biggest gap between growth and value stocks in recorded history," Mr. Bogle says.
Several studies suggest that gap should close. Vanguard, the nation's second-largest mutual-fund firm, recently examined how a hypothetical $10,000 investment would have fared over a 20-year period if it had been invested in the Russell 1000 Growth Index vs. the Russell 1000 Value Index. The conclusion: between January 1979 and February 1999, $10,000 in the growth index would have ballooned to $239,899; invested in the value index, the sum would have swelled to a nearly identical $238,343 in the same period.
Jeremy Siegel, a finance professor at the Wharton School at the University of Pennsylvania, found that value stocks actually did modestly better than large growth stocks in the 35 years between July 1963 and December 1998. He calculated that growth stocks produced 12% a year while value stocks generated 13.4% annually over that period. But Mr. Siegel says he believes the comparison is skewed by an anomalous period of outperformance by value stocks in 1975-1983. Otherwise, "growth outperformed by a big margin."
Interestingly, some studies conclude that small value stocks do greatly outperform small growth stocks. From 1963 to 1995, small-cap value stocks delivered 23% a year, substantially outperforming the 12% annual return of small-cap growth stocks, according to Tim Loughran, an associate finance professor at the University of Iowa. A possible explanation: Small-cap growth companies fail more rapidly than do small companies representing "real businesses in more mundane industries," says Thomas McManus, portfolio strategist at NationsBanc Montgomery Securities.
How long will the current growth-stock fervor persist? Some experts think current economic conditions, including increased globalization and low inflation, favor the big growth stocks. But others fear that growth stocks have pulled too far ahead of value stocks.
"As price-earnings ratios rise higher and higher with the growth stocks, clearly there's more risk," Prof. Siegel says. "If they don't match earnings expectations, they're going to get hit more than the value stocks," he says, citing the sharp sell-off in Compaq Computer shares after that company warned this week that its earnings would be disappointing.
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