Yesterday, I wrote about how a raft of weak first-quarter results could trip up the S&P 500 and put a dent in its unblemished bull run. My theory: the S&P 500’s stellar performance in 2013 was a result of financial engineering (share buybacks and cost-cutting) and the Federal Reserve’s monetary policy; not strong revenue and earnings growth.
As a result, the S&P 500 and other key stock indices are overbought and overpriced, meaning stocks will have a tough time justifying their lofty valuations if first-quarter results fail to wow investors. And odds are good that they will disappoint. A record 94% of S&P 500 reporting companies revised their fourth-quarter guidance lower.
That is, unless investors fail to realize earnings projections were lowered and reward stocks for beating barely there expectations—it’s not impossible. For evidence, I point to the action in the S&P 500 in 2013.
With stocks on the S&P 500 being overpriced, it’s getting more and more difficult to find equities that will actually perform well based on legitimate metrics, like revenues, earnings, and cash. For the most part, it seems investors punish those stocks that don’t perform as well as expected by simply not lifting their share prices higher. As a result, it’s become increasingly difficult to build a balanced portfolio with both growth and value stocks—especially when you consider the fact that analysts expect the S&P 500 to grow just six percent in 2014. Analysts might be more optimistic about the S&P 500 long-term, but that’s of little solace for investors hoping to actually make money this year.
Investors on the lookout for value stocks may need to use a different tactic this year. Instead of looking for fundamentally solid stocks with a low debt load and strong cash position, investors will also need to look for value stocks that are trading down from their pre-recession highs.
Considering downtrodden value stocks in a regular market is easy, but some value stocks become less appealing during a bull market. That’s because stocks that are trading off their previous highs or not gaining traction in a free-for-all bull market must be doing so for a reason. This is a fair assessment; some stocks deserve to be kicked off the cliff, which is why it’s important to understand the value stocks you’re looking at.
And in a year when the markets are not expected to climb in a straight line like they did in 2013, it’s important to also consider value stocks when they dip on overall market weakness.
For example, one stock you may consider is Devon Energy Corporation (NYSE/DVN), an independent energy company with operations in the U.S. and Canada. The company is currently trading about 50% below its pre-recession high and 35% below it’s five-year high. Devon has $4.32 billion in cash, a forward price-to-earnings (P/E) ratio of 9.33, and a price/book ratio of 1.16.
Another option may be Cowen Group, Inc. (NASDAQ/COWN), which offers alternative investment management, research, investment banking, and sales and trading services. The company’s share price is trading down roughly 55% from its pre-recession highs and 50% off its five-year high. Cowen Group has $1.32 billion in cash, a forward P/E of 15.81, and a price/book ratio of 0.92.
Finally, Suncor Energy Inc. (TSX/SU) was in the news last year when it was revealed that Warren Buffett accumulated a stake of 17.8 million shares in Canada’s biggest oil and gas producer. Suncor is currently trading 45% below its pre-recession high and 17% below its five-year high. The company has $5.34 billion in cash, a forward P/E of 11.0, and a price/book ratio of 1.36.
This article These Value Stocks Could Outperform the Market in 2014 was originally published at Daily Gains Letter