Many value investors act as though some rule forbids them from looking at companies with growing businesses. Right now, though, ignoring what some would initially characterize as growth stocks could make you miss out on some of the best values in today's stock market.
A popular myth makes many believe that only staid, boring, mature companies make good value candidates. Such companies rarely have strong growth prospects, but their stock prices have been beaten down so far that even without future growth, just managing to survive can lift their shares substantially higher and give investors a great return.
But despite prevailing opinions to the contrary, there's nothing that makes value and growth investing mutually exclusive. Occasionally, the stocks that give investors the best value are those that have good growth prospects, while more "traditional" value stocks could in fact be overpriced and therefore not optimal investments.
What's happening now
That's an argument that Shannon Zimmerman develops in greater detail in his latest feature for the Fool's Rule Your Retirement newsletter. Among his comments, he provides several reasons why the average value investor should look beyond the usual value universe to seek out the best bargains in today's market.
To see how that proposition might work, I went to our Motley Fool CAPS community to search out companies that had the characteristics of both value and growth stocks. In particular, I looked for large-cap companies with relatively low P/E ratios and debt levels, as well as strong returns on equity and earnings growth over the past several years. I came up with several dozen promising results, including the following:
| Stock | P/E | Long-Term Debt-Equity | Return on Equity | Past 5-Year Earnings Growth |
|---|---|---|---|---|
| Accenture (NYSE: ACN) | 12.0 | 0 | 65% | 19.1% |
| Alcon (NYSE: ACL) | 16.4 | 0.01 | 46% | 21% |
| eBay (Nasdaq: EBAY) | 12.7 | 0 | 15% | 28.2% |
| CNOOC (NYSE: CEO) | 8.1 | 0.09 | 30% | 31% |
| National Oilwell Varco (NYSE: NOV) | 6.0 | 0.07 | 20% | 75.9% |
| Stryker (NYSE: SYK) | 13.4 | 0 | 20% | 17.5% |
| Procter & Gamble (NYSE: PG) | 12.0 | 0.34 | 19% | 13.6% |
Sources: Yahoo! Finance; Capital IQ, a division of Standard and Poor's.
As you can see, stocks that have had strong periods of recent growth aren't always expensive. Right now, in fact, many such stocks are trading at their cheapest levels in years -- possibly because their future five-year growth prospects are less favorable than they have been in the past
Why the disconnect?
Nevertheless, many investors can't get past the idea that value stocks and growth stocks are natural opposites. However, recent events have prompted many value investors to re-evaluate their stock-picking methods.
During 2007 and 2008, many value seekers were trapped by financial stocks, whose initial plunge turned into falling knives as the financial system came to the brink of collapse. Even with strong rebounds in recent months, long-term shareholders of financials have yet to come close to recovering all of their losses -- and many suffered permanent, near-total losses from investments in institutions like Lehman Brothers, Washington Mutual, and Bear Stearns.
The best of both worlds
Now, the right strategy may be to seek out stocks that not only trade at reasonable valuations but also are poised to become even stronger businesses in the future. During most market environments, you'll typically pay up for stocks with good growth prospects -- but the stocks referenced above, and many others like them, illustrate that you now have a unique opportunity to pick up stocks with decent growth on the cheap. That's a better value than you usually get from growing companies.
In particular, Shannon sees a select group of growth stocks outperforming both their value-oriented rivals as well as other stocks in the growth realm. His analysis -- which is available to Rule Your Retirement subscribers -- will put you on the right path to finding some of the best potential value-growth hybrid investments.
Regardless of which stocks you pick, the lesson to take from this is that whenever you arbitrarily narrow down the universe of stocks using certain criteria, you limit how many good stocks you can find. If you can accept the fact that growth stocks can also be good values, you won't miss out on some great investments.
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