By Philip van Doorn
The dilemma of the day for many investors is choosing between growth- and value-stock strategies.
Why not pursue both as part of a diversified portfolio?
You might think you are well-diversified with an index fund, but it probably isn’t true.
We spoke with Kimball Brooker, the deputy head of the global value team at First Eagle Investment Management in New York, and Alan Barr, a senior analyst and associate portfolio manager at First Eagle. In an interview, they shared their thoughts about value investing as well as the pros and cons of stock screening. They provided an example, below, of a value stock of a large company with a path for growth.
The S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.47% is tracked by numerous passively managed funds, such as the SPDR S&P 500 ETF /zigman2/quotes/209901640/composite SPY +0.44% , which seek to mirror its performance by holding all 500 stocks in the right proportions. The index is weighted by market capitalization. This is what makes it less diversified than many investors realize.
Tesla Inc. /zigman2/quotes/203558040/composite TSLA -0.57% will be added to the S&P 500 on Dec. 21, replacing Apartment Investment & Management Co. /zigman2/quotes/209177534/composite AIV +0.96% . If we were to add Tesla’s market capitalization to that of the S&P 500 as of the close on Dec. 11 and remove Apartment Investment & Management Co., we would have a value of $30.96 trillion for the index. Here’s a breakdown of the top 10 companies in the adjusted S&P 500:
Apple Inc. /zigman2/quotes/202934861/composite AAPL +1.14% is the largest component, by far, making up 6.7% of the adjusted index’s market cap. The top five companies (including both share classes of Alphabet Inc.’s Class C /zigman2/quotes/205453964/composite GOOG +1.34% and Class A /zigman2/quotes/202490156/composite GOOGL +1.18% shares, placing them together in 4th place above), make up 22.7% of the adjusted index’s value. The top 10 account for 29.5%. That is a high concentration of risk, which has worked out very well in recent years as the largest tech stocks have soared.
The S&P 500 includes both growth and value stocks, but as you can see, the growth camp dominates.
Why not diversify in two ways, by adding exposure to value stocks, as well as stocks listed outside the U.S.? There are many opportunities around the world in growing markets. You can even diversify further with some active management to add variety to a portfolio that probably already includes a passively managed U.S. fund.
Getting back to First Eagle Investment Management, Brooker co-manages the $45 billion First Eagle Global Fund /zigman2/quotes/209317528/realtime SGENX -1.06% and the $14 billion First Eagle Overseas Fund /zigman2/quotes/209014684/realtime SGOVX -1.49% . Both are rated four stars (out of five) by fund-research firm Morningstar.
The Global Fund had a 38% allocation to U.S. stocks as of Oct. 31, with 36% in non-U. S. stocks, 19% in gold-related investments and 6% in cash. The Overseas Fund was about 67% invested in non-U. S. stocks, with 18% in gold-related investments and 13% in cash.
Both funds have a value focus with capital preservation as an important goal. Their diversification away from the broad, cap-weighted S&P 500 means they can underperform the U.S. benchmark during a bull market. But see this 30-year chart comparing the First Eagle Global Fund (excluding sales charges) with the S&P 500:
That chart may remind you of the tortoise and the hare. The First Eagle Global Fund’s rise has been steadier.
The S&P 500’s forward price-to-earnings ratio, based on weighted average aggregate estimates among sell-side analysts, has increased to 22.1 from 18.3 at the end of 2019, according to FactSet.
When asked during an interview about how he and colleagues might begin their investment-selection process in an expensive market, Brooker called the idea of screening stocks “seductive,” especially when the stock market is at a high valuation.
“Some people like the idea of things being quantified and having human emotions taken out — a systemization of process that is repeatable,” he said. “But our view is the world is more complex.”
He explained that although First Eagle’s analysts will do some screening by the numbers, the more important part of the process is qualitative analysis of companies’ management teams and whether they are “honorable people.”