It has been a fun ride for growth stocks the past few years, but it looks as though value stocks are coming back into vogue and that’s got portfolio managers optimistic about their chances as we enter 2018.
What’s really interesting is that growth-fund managers are the ones giving value stocks the once-over.
“There may be positive momentum in the stock market right now, but that is only going to make it more expensive,” said Matthew Watson, a portfolio manager with James Advantage Funds. “We think that the only choice you have now to find opportunities that will pay off in the long-run is to look for value.”
In 2017, the S&P 500 Value Index was up 12.6%, half the annual rate of return for the S&P 500 Growth Index. As Watson suggests, portfolio managers have little choice but to rotate out of growth stocks and into value stocks.
That’s especially true if you believe in stocks reverting to the mean.
As January marches on, here are the seven best S&P 500 value stocks to own now.
Best S&P 500 Value Stocks to Buy Now: Berkshire Hathaway (BRK.B)
Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) is the largest weighting in the S&P 500 Value Index, a group of 391 S&P 500 value stocks determined by three factors: Book value to price, earnings to price and sales to price. Without getting into the intricate details of its methodology, the lower each of the three ratios, the better.
Berkshire Hathaway had a total return of 22% in 2017, its second consecutive year delivering a return of 20% or higher, putting BRK.B at its highest level since its creation in 1996. No longer is the company’s stock a slow grower, and a couple of recent changes should help it keep moving higher.
First, the change to the corporate tax rate from 35% to 21% is expected to add $37 billion to the company’s book value as a result of reduced tax liability on appreciated assets. Also, the lower tax rate could boost the company’s earnings by 12% in 2018 alone.
Unrelated to the tax change, Berkshire Hathaway announced Jan. 10 that it was adding two company executives to its board to expand the number of directors from 12 to 14. Gregory Abel becomes vice chairman of its non-insurance operations while Ajit Jain becomes chairman of its iconic insurance operations. More importantly, it clears the way for Warren Buffett’s successor as CEO.
I consider Berkshire Hathaway to be a giant mutual fund or ETF — and it just got a whole lot more attractive.
Best S&P 500 Value Stocks to Buy Now: Costco (COST)
Just when investors were starting to write off Costco Wholesale Corporation (NYSE:COST) as a dinosaur that couldn’t adapt to the world of online sales, Costco delivered a very strong December with same-store sales up 11.5% over last year including a 33.3% gain from e-commerce, an unbelievable number given there seemed to be a general belief that Costco was not keeping up with Amazon.com, Inc. (NASDAQ:AMZN).
However, BMO Capital Markets analyst Kelly Bania had good things to say about the company in December after Costco reported better-than-expected Q1 2018 earnings.
“We believe an acceleration in Costco’s online business is in early stages and could continue to support a strong comp outlook and higher valuation as the company widens its competitive moat,” Bania wrote in a note to clients. “We believe that Costco now has more valuation support given its potential to gain a greater share of total wallet from its loyal membership base.”
I’ve been a fan of Costco for some time. December’s results only confirm my suspicions.
Best S&P 500 Value Stocks to Buy Now: Walt Disney (DIS)
Another company that has been written off by analysts as a has-been is Walt Disney Co (NYSE:DIS). However, after discussing with a business-savvy Star Wars fan, I’m convinced its best days might be ahead of it.
As my friend pointed out to me, the potential acquisition of Twenty-First Century Fox Inc’s (NASDAQ:FOXA) entertainment businesses means Disney also acquires the distribution rights to the original Star Wars movie, Episode IV: A New Hope, as well as all the subsequent Star Wars films produced before 2015.
Fox co-financed and co-produced the original 1977 film, which gave it distribution rights in perpetuity. The other films’ distribution rights were scheduled to transfer to Disney in 2020. A deal within 12-18 months would see them move to the company a year earlier.
With Disney launching a video streaming service in 2019, the $66 billion acquisition gives the company significant new content to put on the service, making a far more formidable competitor to Netflix, Inc. (NASDAQ:NFLX).
Disney has suddenly become a value stock that’s ready to grow, which is the best kind.
Best S&P 500 Value Stocks to Buy Now: 3M (MMM)
Some investors probably view General Electric Company (NYSE:GE) as the most accurate industrial value stock at 17 times its forward earnings, but I’m going to go with 3M Co (NYSE:MMM) instead, despite the fact its forward price-to-earnings ratio is 25, or almost double GE’s.
In September 2017, I included MMM in a group of seven stocks I thought would beat the pros. Since that time, MMM is up 15%, 500 basis points higher than the S&P 500.
My rationale for buying MMM still stands despite its nice run over the past four months.
“The best part about 3M’s business is that all five of its operating segments have healthy margins making it very easy to keep paying dividends. It’s able to generate these healthy margins by devoting its entire focus to science,” I wrote on Sept. 20. “Scotch tape might be the ultimate product produced but its the time in the lab researching and understanding the science behind the product that keeps the company innovating for growth.”
Oh, about those margins.
In its Q3 2017 report released in late October, the company announced that its operating margin hit 25% in the quarter, it’s highest in more than a decade.
Best S&P 500 Value Stocks to Buy Now: Church & Dwight (CHD)
Church & Dwight Co., Inc. (NYSE:CHD) has to be one of my favorite stocks of all time. Its name sounds like a law firm, but the consumer products it sells are used daily by millions of people around the world.
Although products like Arm & Hammer, Trojan, Oxi Clean and Waterpik are household names, the stock’s track record is what keeps me positive about the company.
In 2016, I highlighted the fact CHD stock hadn’t had a losing year over the past decade. In 2016, it was up almost 6%, but underperformed the S&P 500; it did the same thing in 2017, gaining 15% to the index’s 22% and it’s down slightly in 2018.
You might be tempted to think its best days are behind it, but you’d be wrong.
Its Q3 2017 report exceeded expectations and fiscal 2017 is shaping up to be another healthy year with free cash flow expected to exceed net income with adjusted EPS growth of 8.5%.
Church & Dwight is a company with a history of underpromising and overdelivering. Of all the S&P 500 value stocks to own, this would be at the top of the list.
Best S&P 500 Value Stocks to Buy Now: Gap (GPS)
After a strong 2017 in which Gap Inc (NYSE:GPS) stock gained 55% on the year, it’s already lost more than 5% of those gains in the early going of 2018.
But don’t think it’s time to abandon ship. This party’s just getting started because regarding value, real value, there probably isn’t a better retail stock to own right now.
Morningstar uses a metric called Cash Return which is defined as free cash flow plus net interest expense divided by enterprise value. Its cash return is 7.8%. By comparison, Costco, which I’ve already selected, is 4% or almost half Gap’s.
That’s what I call value.
Now, by no means is Gap the perfect stock. Banana Republic has been underperforming for as long as I can remember … but even there, business appears to be improving ever so slightly. The retailer’s overall same-store sales in December were up 4% this year, a 900 basis point improvement over a year earlier with Old Navy leading the way up 12% in the month, considerably better than the negative 7% in December 2016.
InvestorPlace’s Luke Lango thinks investors should move on as the best gains have already been gotten. I think there’s more to be had, and any further decline in its stock price will provide an excellent entry point.
Best S&P 500 Value Stocks to Buy Now: McDonald’s (MCD)
Here’s the craziest rumor of 2018.
McDonald’s Corporation (NYSE:MCD) stock delivered a year to remember in 2017, up 45% on the year, a third consecutive year delivering for shareholders.
And why not.
The restaurant chain delivered comparable store sales growth in all of its markets and it sold its China and Hong Kong business for an $850 million gain. Heading into 2018 with considerable momentum, its plans for its value meals should keep the ball rolling.
So, here’s the crazy idea I was talking about at the beginning.
McDonald’s buys Chipotle Mexican Grill, Inc. (NYSE:CMG) for a lot less than they would have paid before the E. coli disaster and leverages its operational excellence to reignite sales at the Mexican restaurant chain.
Look, I know it won’t happen because McDonald’s CEO Steve Easterbrook wants to keep the turnaround moving in the right direction and McDonald’s probably doesn’t want to revisit its past, but I think it’s an intriguing idea nonetheless.
As restaurant stocks go, McDonald’s will always be at the top of the heap.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.