The extended run of relative underperformance for value versus growth – which has now reached about 15 years – has been well documented. This period coincided with widespread disruption, as companies on the wrong side of innovation have seen valuation multiples shrink – while in some cases, valuations have priced in legitimate existential risks. 
As is also quite well known now, the challenges facing value stocks have intensified this year. In certain sectors, the economic damage stemming from the ongoing coronavirus pandemic heaped cyclical pressures on top of longstanding secular – primarily tech innovation – headwinds.
The current global health crisis also accelerated the adoption of disruptive technologies – such as e-commerce and streaming media, as well as cloud-based software supporting the remote working phenomenon. In addition to this, the enduring fear and uncertainty led investors to disregard valuations and embrace well-understood growth stories during the recovery rally.
Growth at any cost
The behaviour we witnessed during the recent period of risk aversion was certainly unusual. Value stocks with higher dividend yields are usually a safe haven in times of anxiety, but the extreme economic uncertainty spurred fears about whether companies could maintain payouts.
The market’s embrace of secular growers at any cost and reluctance to take on cyclical exposure help explain why 92 per cent of the stocks in the Russell 1000 Growth index outperformed the Russell 1000 Value index over the trailing 12 months to 30 June. This trend has pushed the valuation gap between growth and value equities to the highest level since the early 2000s.
We believe these excesses to eventually unwind, or at least moderate. However, we are not trying to call the timing of a turn in the growth value performance cycle – especially a sustainable reversion. Instead, we remain focused on finding high-quality companies trading below intrinsic value and capitalising on opportunities where a shorter-term dislocation could be resolved over time.
Cheap is not enough
Like always, investors should not be tempted by the cheapest stocks, but rather identify the most compellingly valued names relative to long term prospects. For example, the financials sector – the largest sector in the Russell 1000 Value index – contains many cheap stocks in our view. This is due to concerns about economic weakness resulting from the coronavirus pandemic, as well as the implications for bank credit quality and insurance claims, and the effect of lower interest rates on financial results. Nevertheless, cheap is not enough.
In the financials space, any potential revaluation depends on idiosyncratic, company-specific factors – such as cost reductions or better-than-expected credit performance. Potential catalysts go beyond macro factors, such as an improved outlook for the economy or expectations for an uptick in interest rates. Both Morgan Stanley and Chubb are among our top holdings in this sector.
Elsewhere, we also see opportunities where the market has priced cyclical risks as secular, overlooking the potential for improvement in company and industry fundamentals. Below, we highlight five currently unloved stocks displaying compelling longer-term fundamentals.
TJX Companies
The off-price retailer was forced to close locations in the early days of the pandemic. However, we expect the company to be a beneficiary of dislocation within other areas of retail – namely department stores – and be in a stronger competitive position on the other side of the pandemic through market share gains and a healthier consumer. Additionally, we believe TJX Companies has the balance sheet strength that may be required in this uncertain operating environment.
Cummins
This commercial vehicle maker has been surrounded in controversy tied to the company’s historical reliance on diesel powertrains. However, the company has made significant strides in the development of alternative-power technologies and will benefit from both increasing industry demand and market share gains over the coming quarters.
Welltower
While the senior housing operator has near-term challenges related to Covid-19 pandemic, the company led by an astute management team, is well-positioned in an industry with very favourable long-term demographic trends favouring “active life-style” living.
Becton, Dickinson and Company
Commonly known as BD, this med-tech company has faced controversy over an infusion pump recall, as well as concerns over the competitiveness of its recently launched Covid-19 tests. However, it remains poised to benefit from improving global healthcare utilisation and impressive growth in its under-appreciated life-sciences business.
International Paper
The largest supplier of containerboard in the US, International Paper’s valuations are depressed due to concerns over new containerboard supply. However, we remain optimistic about its prospects, as the industry increasingly benefits from demand growth linked to robust growth in e-commerce trends and the company’s assets are some of the lowest cost in the world.
Heather McPherson is portfolio manager of the T. Rowe Price US Large Cap Value Equity Strategy. The views expressed above are her own and should not be taken as investment advice.