For the past decade, pricey growth stocks have made traditional value investing look downright foolish. Value stocks, often defined as having low price-to-book or price-to-earnings ratios, have languished relative to richly valued growth stocks. The art of valuation has been tossed aside; instead, unprofitable companies with sometimes questionable business models have been valued in the billions of dollars. Growth has been all the market cares about.
As famed value investor Warren Buffett has said: "Only when the tide goes out do you discover who's been swimming naked." While it's too early to be sure, the stock market appears to be shifting hard toward value. Shares of some high-flying growth stocks have been hammered recently for no apparent reason, and shares of many value stocks have jumped. If the tide is truly turning, investors who have been willing to pay ever-higher prices for growth are in for quite a shock.
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In the long run, value stocks tend to outperform growth stocks. Being a value investor means that you'll look dumb while growth stocks are trendy, but that's a small price to pay for market-beating returns. And you'll sidestep the monstrous downside that comes with growth stocks and their nosebleed valuations.
Which value stocks should you buy? There are plenty of options, but International Business Machines (IBM +1.13%), Hanesbrands (HBI +0.00%), and Tanger Factory Outlet Centers (SKT +0.66%) are my top picks. Here's why.
Don't underestimate IBM
Shares of tech giant IBM, known for its mainframe computers and vast IT services business, haven't done much in the past few years. The stock has languished as the company mounted a multiyear transformation, investing in cloud computing, artificial intelligence, and other growth areas while pulling back in certain legacy businesses.
The result has been declining revenue and a cloud of pessimism hovering over the stock. Since peaking in 2013, shares of the century-old tech company have lost about one-third of their value.
But underestimating IBM would be a mistake. The company is betting that its large customers will embrace hybrid, multicloud computing, spreading workloads across a mix of on-premise hardware and various public clouds. With the acquisition of Red Hat, IBM is positioned to deliver on that vision, and it has a multibillion-dollar opportunity to sell its existing customers on Red Hat software.
The Red Hat deal will hurt IBM's earnings this year due to various one-time, noncash charges. The company expects to produce adjusted earnings per share of $12.80, along with free cash flow of roughly $12 billion. That puts IBM's price-to-earnings ratio just over 11, and its price-to-free cash flow ratio at about 10.5.
It's not hard to see how this can turn out well for long-term investors. A combination of earnings growth in the coming years and a more optimistic valuation as the company's strategy takes hold has the potential to drive huge gains in the stock. While many other cloud computing stocks are priced for perfection, IBM is priced for failure. That's an opportunity for value investors.
A basic apparel bargain
The trade war between the U.S. and China, as well as fears of a recession coming soon, has given investors plenty of reasons to avoid apparel stocks like the plague. But it would be a mistake to write off Hanesbrands. The company's geographically diversified manufacturing base, much of which it owns itself, makes Hanesbrands a unique apparel stock for an uncertain economic climate.
More than 70% of Hanesbrands apparel units are manufactured in the company's own plants, or in the plants of dedicated contractors. This gives Hanesbrands a cost advantage over competitors that outsource manufacturing entirely. The company's 48 manufacturing facilities are located primarily in Asia, Central America, and the Caribbean Basin, and the company believes that alternative sources of materials and services are readily available.
The underwear business isn't recession-proof, so Hanesbrands' sales will likely decline during the next downturn. But Hanesbrands isn't just an underwear company. The Champion brand of activewear is growing rapidly, which should help offset any weakness in the core business.
Hanesbrands' Champion brand is growing. Image source: Hanesbrands.
Hanesbrands expects to produce between $1.72 and $1.80 in per-share adjusted earnings in 2019, a slight growth from 2018. The bankruptcy of Sears hurt the bottom line a bit this year, and there's always the risk that other retailers will go under. With Hanesbrands stock trading around $15 per share, the price-to-earnings ratio is just 8.5.
That seems awfully cheap, especially considering that Hanesbrands has posted eight consecutive quarters of organic sales growth. Hanesbrands isn't an exciting stock, so no one is really paying attention to it, despite its beaten-down valuation. In other words, it's the quintessential value stock.
A mall REIT worth buying
Many shopping malls are in trouble as traffic dries up and department stores struggle to survive. But that doesn't mean there are no good deals among real estate investment trusts (REITs) that specialize in shopping centers. Tanger Factor Outlet Centers looks like a steal, even as it muddles through a difficult year.
Tanger operates 39 outlet centers across 20 U.S. states and Canada. The company has been around since 1981, and it survived the financial crisis a decade ago without breaking much of a sweat. Today, Tanger is dealing with an upheaval in the retail industry as well as the potential for a recession in the near future. Its performance has suffered due to retailer bankruptcies, and that headwind will likely persist for a while.
Tanger's adjusted funds from operations will decline this year, along with average occupancy and other metrics. The company expects AFFO per share between $2.25 and $2.31, putting the stock price at less than seven times the midpoint of that range. Because the stock price is so depressed, Tanger's dividend yield is currently above 9%.
There's no doubt that Tanger is feeling some pain from the current retail environment, and that pain could intensify if there's an economic downturn. But there's little reason to believe the company won't survive, given its track record. The time to buy Tanger is right now.
