3 Under-the-Radar Stories in the Stock Market This Week – Motley Fool

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If someone is trying to beat the market, they need to develop a variant perception. In order to do this, it’s necessary to focus on situations or information that the consensus view is under-weighting or ignoring.

Here is some fascinating data on “value” stocks and gold, courtesy of Credit Suisse, and the notion that Advance Auto Parts, Inc.‘s (NYSE:AAP) Wednesday “pop” may not reflect a longer-term shift in the business.

Image source: Getty Images.

What’s ailing “value” stocks?

The 2018 Credit Suisse Global Investment Returns Yearbook was published this week. Produced annually by academics Elroy Dimson, Paul Marsh, and Mike Staunton, who take a long-term lens to investing — normally anathema to investment bank research publications — the report is  a cornucopia for serious fundamental investors.

This year’s report devotes a chapter to “factor investing,” a fashionable development in the fund management industry. Factor investing seeks out stocks that share a specific characteristic, or “factor,” such as value, momentum, or low volatility. The objective is to outperform the broad market, so factor investing funds are sometimes referred to as “smart beta” or “enhanced beta” products (beta is a term from academic finance that refers to the market return).

“Value” — stocks with a low price-to-earnings or price-to-book multiple — has been a winning strategy over the long term, with low price-to-book multiple stocks returning 13% on an annualized basis, between 1926 and 2017 — a 3.5 percentage point advantage over the broad market. However, as Dimson, Staunton, and Marsh point out, the last few years have not been kind to value, which has lagged the market (not to mention growth stocks) by a wide margin:

VOOG Total Return Price data by YCharts

It’s not difficult to find the source of that under-performance — just compare the top 10 holdings in the Vanguard S&P 500 Value ETF (NYSEMKT:VOOV) against those of the regular Vanguard S&P 500 ETF (NYSEMKT:VOO), for example. Missing from the first list are Apple Inc., Alphabet Inc, Amazon.com, Inc. and Facebook Inc — four of the five “FAANGs,” which have put up stunning returns over the past several years:

FB data by YCharts

Value’s under-performance makes one wonder if its return is coming. Is it time for investors bet on value stocks?

I’m a believer in mean reversion in financial markets, so I think value stocks will gets their day in the sun again, but there are a number of problems with such a bet. First, I’m concerned about the overweighting in consumer staples shares in smart beta value funds, due to a phenomenon I’ve mentioned here.

Second, as Michael Mauboussin, the director of research at BlueMountain Capital Management and a Motley Fool favorite, pointed out in an interview recently, people conflate value investing with the idea of buying statistically cheap (i.e., low multiple) stocks, which can produce two errors:

The first is buying a statistically cheap stock that deserves to be even cheaper. That’s a value trap. The second is shunning a statistically expensive stock that represents a good value.

If someone is going to make what amounts to an active bet by buying something other than broad market indexes, why not make the effort to analyze stocks bottom-up, as ownership interests in a business. Most investors won’t overcome the hurdles of time and expertise (and interest level) required. However, for those who do, thinking about specific businesses seems a lot more interesting (and is potentially much more lucrative) than just focusing on “cheap” stocks.

Image source: Getty Images.

Gold/precious metals: The cost of insurance

For several years, I’ve warned investors that while gold has kept up with inflation over ultra-long time periods, it’s much too volatile to be considered a store of value for any practical purpose. The Credit Suisse Returns Yearbook provides some illuminating data in this regard.

Gold did keep up with inflation between 1900 and 2017, with an annualized real return of 0.7%, but that’s lower than bonds (2%-plus) or cash (Treasury bills, at 0.8%-plus).

One chart shows that gold also under-performed global equities (5.2%-plus), while simultaneously exhibiting greater volatility (so did silver and platinum).

(For reference, U.S. stocks produced an annualized real return of 6.5% over the same period.)

Lower returns and higher volatility? That’s not an attractive combination.

Let me restate those facts so that they may sink in: Over a 118-year stretch, gold has under-performed cash, while subjecting investors to volatility that is higher even than stocks’. When someone buys gold, they’re getting a very expensive insurance policy against inflation and deflation. There are better hedges against these phenomena — high-quality stocks, for example. And speaking of stocks…

Image source: Getty Images.

Advance Auto Parts: A hard steering change

Advance Auto Parts, Inc. was the best-performing stock in the S&P 500 on Wednesday, up 8.2%, after the auto parts retailer reported better-than-expected fourth-quarter results. That begs the question of how this is one of the most under-the-radar stories this week.

Let me be clear: Wednesday’s revaluation may be appropriate in the context of stocks’ average holding period (less than two years), but, for a patient investor, there is more to the story.

Advance Auto Parts’ problem is that of the entire traditional retail sector is in a world that appears increasingly to belong to Amazon.com. Nevertheless, not all retailers are reacting with the same hard-nosed realism to their quagmire… err, situation.

Barron’s‘ Alex Eule highlighted some comments from the earnings call that show that this retailer has taken the measure of the threat and is acting accordingly. CEO Thomas Greco told investors and analysts that management has “tried to align our entire organization around the online offering so that we’re actually compensating our general managers for buy online/pick up in store, and buy online/ship to home.”

Many retailers have proven incapable of changing their thinking that way and while that shift doesn’t guarantee success, it’s worth noting that, even following Wednesday’s bump, the stock remains the worst-performing of its mid-/large-capitalization peer group over the past three years. There may be more under Advance Auto Parts’ hood than investors are giving the stock credit for.

(Still, at a forward price-to-earnings multiple of 16.7 — just below Advance Auto Parts’ 17 times — I prefer alternative and specialty auto parts supplier LKQ Corporation (NASDAQ: LKQ).)

Quote of the week

This is not just a bubble. It is not just a fraud. It is perhaps the outer limit, the ultimate expression, of the ability of humans to seize upon ether and hope to ride it to the stars. — Paul Singer, founder of hedge fund manager Elliott Management Corp., writing about bitcoin in a Jan 26 letter to his investors.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Alex Dumortier, CFA has no position in any of the stocks mentioned, nor in any cryptocurrencies mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Facebook, and LKQ. The Motley Fool has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, short March 2018 $200 calls on Facebook, and long March 2018 $170 puts on Facebook. The Motley Fool has no position in any cryptocurrencies mentioned. The Motley Fool has a disclosure policy.

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