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Value Stock Crash Reaches 50 Per Cent

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Value Stock Crash Reaches 50 Per Cent

by Steve Selengut

Perhaps this (totally ignored by the media) snippet will pique your attention: on December 18, 2007, nearly 50% of all Investment Grade Value Stocks were down an average of over 30% from their 52-week highs... the Dow and the S & P 500 had fallen just 7%!

One would think that there would be a pretty clear distinction between Value Stocks and Growth Stocks. But an hour or less research, and some non Wall Street analysis, will muddy the waters significantly. In the back of our minds, most investors think of Value Stocks as more conservative investments than Growth Stocks, mostly larger, proven, and profitable companies that are quite a bit safer than their Growth Stock brethren. Value stocks, you will determine, are those that:

* Tend to trade at a lower price relative to their fundamentals.

* Are undervalued and have a good expectation of price appreciation.

* The marketplace perceives to be undervalued based on criteria such P/E, price-to-book ratio, dividend yield, etc.

* Have been out of favor and are relatively cheap compared to the value of their assets.

* Trade at a P/E ratio lower than the market average P/E ratio as a result of falling prices rather than improving fundamentals.

Surprisingly, the distinguishing feature of Value Stocks is price. How does the price of the stock relate to its fundamentals, and if it is truly under-valued, how good are the chances for the price to go up? The definitions mention dividends, various financial statement ratios, and market sentiment. The problem is that there are no real benchmarks or specifics to cuddle up to for selection decision-making purposes. What Wall Street labels as a Value Stock is, in reality, a stock that, at a certain point in time, is selling at a bargain price... a very temporary thing. Once the stock goes up in price, the Value Stock label disappears.

Growth Stocks, on the other hand, are most often thought of as flashy startups, high tech innovators, and generally more speculative entities that should be dealt with carefully. These are the bread and butter of both Growth and Index Funds and are the kind that the media covers most extensively. The most popular definitions describe Growth Stocks as those of companies that:

* Are growing earnings and/or revenue faster than their industry or the overall market.

* Pay little or no dividend, preferring to use their income to finance expansion.

* Are young, with little or no earnings history, and which are valued on the basis of anticipated future earnings.

* Have high price-earnings ratios.

* Are currently growing earnings with potential to continue growing earnings 15% to 30% annually for the next one to three years.

Equally surprising, to me anyway, is that price is only mentioned as a part of the high P/E ratio expectation that seems consistent with the Growth Stock identity. This is because price is a tertiary consideration in this inherently speculative area, and not nearly as relevant as those quarterly analyst projections that fuel the hysteria... in both directions.

I don't disagree with the need for distinctions such as this, but I have a problem with the lack of consistency in who does the labeling, how unbiased it can possibly be, and then this one big problem: almost any stock out there can be seen as one or the other, even at the same time, by almost anyone who owns a calculator and who thinks they have the ability to predict the future. Are the real estate, home building, and financial Growth Stocks of the past three years now Value Stocks, and which of the current Value Stocks will achieve Growth Stock prominence in 2008 or 2009? Similarly problematic is the perception that a Value Stock must be safe and full of quality and the assumption that a Mutual Fund full of Growth Stocks just has to grow in... value!

Its time to refine these definitions a scooch, if for no other reason than to recognize that both are purposely flexible concepts that attempt to compare current equity prices either with past accomplishments or with future potential. Two things about publicly traded companies that most investors and speculators would probably agree upon are these: (1) High P/E, unprofitable, non-dividend paying, young companies are less likely to be around in their present form 10 years from now than profitable, dividend paying, low P/E, established companies; and (2) That the current Market Price of a security is as much or more a function of supply and demand, current events and their media spin, and world politics than it is a function of the company's financial statements. BUT, spending more time inside a company's financial statements certainly helps in identifying: stability, consistency, general quality, and long-term economic viability.

In other words, what I am looking for is a selection universe of fundamentally valuable companies that can be expected to remain that way for a significant period of time, not just a bunch of random symbols that someone believes are at garage sale prices. With a stable, fundamental-value or quality universe to select from, we can use Market Price to determine both: when a stock is available for purchase at a bargain price, and when each of our individual holdings has grown enough for us to realize a reasonable profit.

S & P Corporation publishes a standardized earnings and dividends ranking system which separates stocks with average and better fundamental qualities from those with lesser economic strength and viability. It is particularly useful because it excludes market analysis and projections of the future, thus eliminating any form of hype whatever. It sticks with pure fundamentals, financial report numbers, and ratios... market price is not an issue. As with all marketable securities, every member of this select group of approximately 450 higher fundamental quality companies will vary in Market Price in either direction dependent on all of the usual market factors... but their basic quality remains constant, regardless. I think of this group of especially successful companies as Investment Grade Value Stocks, and I look to them to produce above average growth in Working Capital annually and in Market Value cyclically. Experienced investors know better than to relate Market Price with the soundness of a company's financial statements... particularly during stock market corrections.

Four new sets of statistics are being developed for the FREE and exclusive use of true Value Investors, and they should be available on the web early in 2008:

* The Investment Grade Value Stock Index (IGVSI), which tracks the Market Value of the stocks described above.

* Issue Breadth Statistics, of the approximately 450 stocks in the IGVSI, track the daily number of advancing and declining issues.

* New High and New Low Statistics help to pinpoint cyclical developments within the Equity Universe.

* A monitor of the number of "bargain stocks" within the IGVSI helps to confirm uninvested smart cash levels in equity portfolios.

Note: The 2nd Edition of "Brainwashing" is here!
Steve Selengut
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read",
and "A Millionaire's Secret Investment Strategy""