Where the Real Value Is Now

If you can anticipate where the investing crowd will go next rather than simply follow the herd, your portfolio will perform a lot better. So when you're seeking attractive investments, looking back at past results can help you -- but not in the way that most people use them.

Looking at the rally
Overall, the stock market has seen some amazing gains over the past six months. Although you could chalk up the initial bounce off the early March lows to relief that the financial system had avoided imminent collapse, the gains during the second and third quarters also incorporated a strengthening belief that the economy would improve and that businesses would begin to prosper again.

Yet some industries have recovered more strongly than others. Here's a comparison of how stocks in different industries have performed over the past six months:

Source: Morningstar. Returns are for Select Sector SPDR ETF for each industry.

As you'd probably expect, financial stocks have soared as the immediate threat to their industry began to subside. Meanwhile, stocks in traditionally defensive industries, such as consumer staples and utilities, have held back during the rally, and health-care stocks have suffered as their industry has come under intense scrutiny as part of the debate over government health-care reform.

Is the obvious strategy the best one?
The obvious value strategy is to concentrate on the one or two worst-performing sectors and look for bargains among them. Several utility stocks look like great values right now, and companies such as Johnson & Johnson (NYSE:JNJ) are making the best of health-care bargains by ramping up acquisitions, following in the footsteps of drug giants Merck (NYSE:MRK) and Pfizer (NYSE:PFE).

That strategy makes doing research a lot easier. If you think an entire industry is undervalued, you can keep things simple by buying a sector ETF that invests in a wide range of industry stocks. Conversely, if you want to drill down further to identify the best individual stocks, it still gives you a way to focus your efforts so you don't have to do research on hundreds of different companies.

Building a better portfolio
The problem with that approach, though, is that you end up with an undiversified portfolio concentrated in just a few sectors. And while concentration can juice returns if your timing is good, just because a sector does badly in one quarter doesn't mean it's going to pop back up during the next.

That's why I think the better choice is to mix stocks from different sectors. If you want to get fancy, then invest a bit more in stocks from beaten-down industries, but make sure your portfolio includes some companies from better-performing sectors as well. Even where stock prices have increased dramatically, you can still find attractive values. Here's a sample of stocks that look relatively cheap compared with their peers and the overall market.

Source: Yahoo! Finance.

Stocks like these can help you round out a diverse stock portfolio while maintaining a value-oriented investing style. That should give you good results over the long haul, regardless of whether the economy continues on its upward track or suffers a setback in the coming months.

Stick with value
At times like these, following a value-investing strategy takes a lot of discipline. When others are seeing big rewards from sticking with high-momentum stocks that have risen the furthest since the rally began, you might believe that value investing has lost its usefulness.

The key, though, is understanding that value investing isn't just about bottom-hunting. Stocks with true value can be found anywhere, even within industries that have performed extremely well. If you can successfully smoke out those values, then you'll be able to build an overall stock portfolio that will provide both good growth prospects and protection against downturns. That's a risk-reward combination you shouldn't miss.

Do you think you're a smart investor? Read why Anand Chokkavelu thinks you might be too smart to get rich.