Are Cyclical stocks also Value stocks? Value stocks usually earn money, turnaround stocks may not.

What are the characteristics of value stocks?

1. True value investors only buy if a stock is trading substantially below its tangible book value.  It’s hard finding these types of situations in all your investments.  Use this as a guide and not as a “must have.” Over the years, you will have noticed these types of values in the banking, energy and chemical industries, among others.
2. Another factor you need to find in a value stock is a low price to earnings (“P/E”) ratio.  You are looking for a beaten down stock in an out-of-favor industry. A nice P/E discount is 20% to 50% of the industry average over a few years. You then have the potential to make a nice return on both the natural rotation of the industry to a higher timeliness, as well as the stock regaining market favor. 

When is a cyclical stock also a value stock?


Many investors view cyclical stocks as value stocks. Cyclical stocks are value stocks only if they sell at an earnings (P/E) discount to their peers and meet the book value criteria as mentioned above. 




When is a cyclical stock not value stocks but a turnaround stock?


If the company is selling at a discount to its tangible bookvalue, but its earnings have disappeared, it becomes a possible turnaround situation and not a value stock.

****Buffett (1992): Do not categorise stocks into growth and value types, the two approaches are joined at the hip

Warren Buffett's 1992 letter to his shareholders touched upon his views on short-term forecasting in equity markets and how it could prove worthless. In the following few paragraphs, let us go further down through the letter and see what other investment wisdom he has on offer.

Most of the financing community puts stock investments into one of the two major categories viz. growth and value. It is of the opinion that while the former category comprises stocks that have potential of growing at above average rates, the latter category stocks are likely to grow at below average rates. However, the master belongs to an altogether different camp and we would like to mention that such a method of classification is clearly not the right way to think about equity investments. Let us see what Buffett has to say on the issue and he has been indeed very generous in trying to put his thoughts down to words.

"But how, you will ask, does one decide what's 'attractive'? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: 'value' and 'growth'. Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

In addition, we think the very term 'value investing' is redundant. What is 'investing' if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labeled speculation (which is neither illegal, immoral nor - in our view - financially fattening).

Whether appropriate or not, the term 'value investing' is widely used. Typically, it connotes the purchase of stocks having attributes such as 

• a low ratio of price to book value, 
• a low price-earnings ratio, or 
• a high dividend yield. 

Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments.

Correspondingly, opposite characteristics - 

• a high ratio of price to book value, 
• a high price-earnings ratio, and 
• a low dividend yield 

- are in no way inconsistent with a 'value' purchase.

Similarly, business growth, per se, tells us little about value. It's true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing - in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor."

If understood in their entirety, the above paragraphs will surely make the reader a much better investor. We believe the most important takeaways could be as follows:

• Do not categorise stocks into growth and value types. A high P/E or a high price to cash flow stock is not necessarily a growth stock. A low P/E or a low price to cash flow stock is not necessarily a value stock either. 
• Growth in profits will have little role in determining value. It is the amount of capital used that will mostly determine value. Lower the capital used to achieve a certain level of growth, higher the intrinsic value. 
• There have been industries where the growth has been very good but the capital consumed has been so huge, that the net effect on value has been negative. Example - US airlines. 
• Hence, steer clear of sectors and companies where profits grow at fast clip but the return on capital employed are not enough to even cover the cost of capital.
  
  
  
  
  http://www.equitymaster.com/detail.asp?date=12/20/2007&story=2

Growth stocks regain favor after value's long run

January 15, 2010
Growth stocks regain favor after value's long run

Mark Jewell
Growth is in, value is out. And it's likely to stay that way this year.

Investors who loaded their portfolios with growth stocks were rewarded in 2009. Those stocks gained an average 37 percent, nearly twice as much as value stocks.

Growth's notable performance was largely fueled by technology stocks, the biggest part of the growth category. Experts say those companies will continue to prosper as customers ramp up tech spending coming out of the recession. But experts caution a tech rally as big as last year's is unlikely.

There's no pat definition for growth stocks, but typically they generate revenue and earnings at an above-average rate. Examples are Apple and Google. Value stocks generally produce steady earnings, often pay out dividends and are considered cheap based on their price-to-earnings ratios. Companies like Bank of America, McDonald's and Wal-Mart fall into this category.

The leadership shift to growth from value marks a break from historical patterns. All told, the annual performance of growth stocks surpassed value stocks just twice in the last decade. Also, value stocks normally do much better coming out of a recession, as more economically sensitive stocks like banks and utilities rebound at the earliest signs that the economy is expanding.

"Typically, the bigger the contraction during a recession, the bigger the snapback when the economy turns," says Stephen Wood, chief market strategist of Russell Investments. "That hasn't happened this time."

This recovery has been tepid. The economy is growing about half as fast as it usually does exiting a recession, says Wood. Though the stock market has climbed 70 percent since last March, unemployment remains at 10 percent.

Still it's clear that growth stocks were hot in 2009. Growth stocks within the Russell 3000, a broad index covering 98 percent of the U.S. stock market, surged 37 percent last year. Value stocks ended with a more modest 20 percent gain.

That big gap was reminiscent of the late 1990s, when growth had its last big run. Of course that fizzled in early 2000 as the dot-com bust pummeled technology companies.

"What happened in 2009 is not what we should expect going forward," says Jim Swanson, chief market strategist at MFS Investment Management, which manages nearly $188 billion. "We need to look at it as an extraordinary year."

The reality is that certain industries play a pivotal role in driving the performance of growth and value stocks.

Tech stocks are the biggest part of growth, accounting for 30 percent of the value of all that category's stocks in the Russell 3000. Last year those tech stocks finished up an average 59 percent — tops among 11 sectors — boosting growth's overall performance. Two of tech's biggest names put up especially strong results: Shares of Apple and Google more than doubled.

On the value side, financial services stocks are the biggest piece, making up one-quarter of the Russell 3000's value component. While many large banks came back from the brink of failure, their stocks haven't returned to pre-plunge levels. In 2009, financials trailed the broader market despite finishing up 17 percent.

Utility stocks, another value staple, also weighed down the overall performance of the category. They gained just 12 percent last year, less than any other segment of the stock market.

Ultimately, investors trying to forecast whether growth or value will lead the market should closely watch the economy.

In each of the past four recessions since 1980, growth stocks fared better than value as the economy shrank, a Russell Investments study found.

That's because growth companies' competitive advantages — think of Google's search engine dominance, for example — tend to hold up even if the economy is lousy. Value stocks tend to fall more sharply because many are in industries that are unusually sensitive to economic cycles — think of banks that see loan losses multiply in a bad economy, or energy companies that see demand from industrial customers shrink.

When the economy began expanding coming out of past recessions, value stocks began rising faster than growth stocks, the study found.

That's not the case now, so the current market is breaking with the norms. Still, after value stocks led the market nearly all the past decade, Wood, of Russell Investments, figures growth stocks could be in favor for a long while.

But even if they are, don't rush in. Individual stocks don't neatly follow the trend of their broader category. And, perhaps more importantly, Wood says the performance advantage for either growth or value is likely to be narrow.

"2010," Wood says, "will probably surprise us in how normal it will be."

http://www.realclearmarkets.com/news/ap/finance_business/2010/Jan/15/growth_stocks_regain_favor_after_value_s_long_run.html

Value Stocks and Superior Returns

Stocks that exhibit low P/B and low PE ratios are often called value stocks.

Those with high PE and P/B ratios are called growth stocks.

Prior to the 1980s, value stocks often were called cyclic stocks because low PE stocks often were found in industries whose profits were tied closely to the business cycle. With the growth of style investing, equity managers who specialised in these stocks were uncomfortable with the cyclic moniker and greatly preferred the term value.

• Value stocks are concentrated in oil, motor, finance and most utilities.
  
• Growth stocks are concentrated in the high-technology industries such as drugs, telecommunications, and computers.
  
• Of the 10 largest U.S. based corporations at the end of 2001, 7 can be regarded as growth stocks (GE, Microsoft, Pfizer, Wal-Mart, Intel, IBM, and Johnson & Johnson), whereas only 2 (Exxon Mobil and Citigroup) are value stocks; AIG can go either way depending on the criteria used for selection.

A study summarising the compound annual returns on stocks from 1963 through 2000 ranked on the basis of both capitalization and book-to-market ratios appear to confirm Graham and Dodd's emphasis on value-based investing.

• Historical returns on value stocks have surpassed those of growth stocks, and this outperformance is especially true among smaller stocks.
• The smallest value stocks returned 23.26% per year, the highest of any of the 25 categories analysed, whereas the smallest growth stocks returned only 6.41%, the lowest of any category.
• As firms become larger, the difference between the returns on value and growth stocks becomes much smaller.
• The largest value stocks returned 13.59% per year, whereas the largest growth stocks returned about 10.28%.

One theory about why growth stocks have underperformed value stocks is behavioural: Investors get overexcited about the growth prospects of firms with rapidly rising earnings and bid them up excessively. "Story book stocks" such as Intel or Microsoft, which in the past provided fantastic returns, capture the fancy of investors, whereas firms providing solid earnings with unexciting growth rates are neglected.

Another more economically based reason is that value stocks have higher dividends, and dividends are taxed at a higher rate than capital gains. As a result, value stocks must have higher returns to compensate for their higher taxability. However, tax factors cannot explain the wide spreads between small value and growth stocks.

The differences in the return between large growth and large value stocks appears to wax and wane over long cycles.

• Growth stocks gained in the late 1960s and peaked in December 1972, when the "nifty fifty" hit their highs.
• When investors dumped the nifty fifty, growth stocks went into a long bear market relative to value stocks. One of the reasons for this was the surge in oil stocks, which are classified as value stocks, when OPEC caused petroleum prices to soar.
• From 1982 onward, growth stocks gained relative to value stocks, soaring in the technology boom of 1990-2000, only to fall again when the euphoria subsided.
• In fact, large growth stocks have outperformed large value stocks in about half the years since 1963.

BARRA, Inc., a California-based stock research firm, has divided the firms in the S&P 500 Stock Index into two groups of growth and value stocks with equal value on the basis of the firm's market-to-book ratio. Using the ratio of the cumulative return on these two large capitalization growth and value indexes since Dec 31, 1974, when the indexes were first formulated:

• On the basis of capital appreciation alone, growth stocks, with a 11.06% annual return, beat value stocks by 0.31% over this 37-year period.
• However, these value stocks have dividend yields that are about 2 % above that of growth stocks. When dividend yields are included to find total cumulative returns, value stocks' return of 15.6% per year outperformed growth stocks by about 1.9%.
• However, for taxable investors, the difference between the cumulative returns on S&P growth and value stocks has been very slight over the past 27 years, a difference of only 0.69%.

Furthermore, the unprecedented volatility of growth stocks relative to value stocks in recent years has played havoc with historical data.

• For someone who began investing in 1975, the technology bubble of the late 1990s sent after-tax growth returns higher than after-tax value returns from September 1999 through September 2000.
• Once the bubble popped, however, growth stock returns fell back below those of value stocks very quickly.

It should be noted that beginning the growth and value series in 1975 is very favourable for value stocks.

• Large value stocks crushed large growth stocks from 1975 through 1977, when soaring oil prices sent the price of oil and resource firms (which are always ranked as value stocks) skyrocketing.
• Since August 1982, when the great bull market began, cumulative returns for growth and value investors have been almost identiacal, even after the growth stock collapse of 2000-2001.

Also read:

Nature of Growth and Value Stocks

Nature of Growth and Value Stocks

These designations are not inherent in the products the firms make or the industries they are in. The terms depend solely on the market value of the firm relative to some fundamental variable, such as earnings, book value, etc.

The stock of a producer of technology equipment, which is considered to be an industry with high growth prospects, actually could be classified as a value stock if it is out of favor with the market and sells for a low market-to-book ratio.

Alternatively, the stock of an automobile manufacturer, which is a relatively mature indsutry with limited growth potential, could be classified a growth stock if its stock is in favor.

In fact, over time, many stocks go through value and growth designations as their market price fluctuates.

The literature often showed value stocks beating growth stocks. What does this mean?

• As many stocks go through value and growth designations as their market price fluctuates, this implies that stocks become priced too high or low because of unfounded optimism or pessimism and eventually will return to true economic value.
• It definitely does not mean that industries normally designated as growth industries will underperform those designated as value industries.

There is no question that investors always should be concerned with valuation, no matter which stocks they buy.

Nature of Growth and Value Stocks

Nature of Growth and Value Stocks

These designations are not inherent in the products the firms make or the industries they are in. The terms depend solely on the market value of the firm relative to some fundamental variable, such as earnings, book value, etc.

The stock of a producer of technology equipment, which is considered to be an industry with high growth prospects, actually could be classified as a value stock if it is out of favor with the market and sells for a low market-to-book ratio.

Alternatively, the stock of an automobile manufacturer, which is a relatively mature indsutry with limited growth potential, could be classified a growth stock if its stock is in favor.

In fact, over time, many stocks go through value and growth designations as their market price fluctuates.

The literature often showed value stocks beating growth stocks. What does this mean?

As many stocks go through value and growth designations as their market price fluctuates, this implies that stocks become priced too high or low because of unfounded optimism or pessimism and eventually will return to true economic value. It definitely does not mean that industries normally designated as growth industries will underperform those designated as value industries.

There is no question that investors always should be concerned with valuation, no matter which stocks they buy.