Value Fund Investing: My No. 1 Pick
By James H. Lowell III • Bankrate.com

I keep waiting to see crowds of protestors encircling a mutual fund company with placards reading "Down with Value Funds," "The End Of The Bull Market Is NotNear," and "My Value Manager Drives A Yugo."

But value vitriolics aside, now may actually be a good time to consider owning a value fund. Or perhaps you already own a value fund and are quietly wondering what a value stock is exactly -- other than something that has hampered your fund's performance and makes you feel granular every time your pals are talking about their soaring fund profits.

Glad you asked. A value stock is stock in a company that is relatively cheap compared to its earnings or "book value" (mostly tangible assets -- planes, trains, and automobiles, and buildings and machinery). Value stocks tend to be stodgy players in slower-growing, defensive or cyclical areas. In contrast, a growth stock means a share of a company that is relatively expensive compared to its current earnings or assets. Investors buy an expensive growth stock, or bid it up to expensive levels, because they expect the company to grow. Growth stocks tend to have a high price relative to current earnings, and provide little if any dividend, because investors expect the stocks to show above-average growth in earnings and/or sales. This belief is usually founded on a history of growing earnings or sales, or on the company's being in a promising, high-growth sector (technology, biotechnology, developing communications).

In 1999, Internet stocks were the most extreme example of growth stocks. So far in 2000, biotech wears the emperor's new clothes. But no matter how you look at it, value stocks and the funds that invest in them have been left out in the bleak landscape of dismal relative returns.

Almost all fund managers at least pay lip service to the concept of value, and will mention its code words -- on the lookout for stocks that are "bargains," "cheap," "overlooked" and/or "undervalued." It would be a rare -- and short-lived -- manager indeed who claimed to favor stocks that are selling for more than they're worth, or companies sure to be headed for a decline. Even some aggressive growth players claim to be seeking "value-growth" issues, or "growth at a reasonable price." Likewise, even the most value-oriented fund managers prefer a stock that has at least some potential for growth.

So What is Value Investing?

Value investing is based on the contrarian premise that the stock market is less efficient than people think. To the value investor, the Street is populated largely by herd-instinct types. They're too busy running after the latest trend to notice unglamorous companies whose comparatively low share prices don't fairly reflect positives like current profitability or bright future prospects.

Now for the fairy godmother stuff: In the long run, value stocks have tended to outperform growth stocks. After all, an under-performing company simply has to defy people's low expectations, while a growth stock has the more difficult task of meeting the sometimes stratospheric expectations with which the market has burdened it. On the other hand, the danger with the value-investing approach is that what appears to be gold may indeed be little more than fairy dust -- OK, angel dust at this level. And even if that undervalued company remains a solid money-making enterprise, investors too dreamy eyed to see it today could be just as unperceptive tomorrow.

Some Value Managers Are Better Than Others

Even the most cursory review of the value fund club reveals two things that set them apart from the average equity portfolio: low turnover, and low price-earnings (P/E) ratio. The funds that really deserve the value moniker trade 25 percent or less of their holdings each year; some have annual turnover rates as low as 10%. In an environment in which the average stock fund has an 85 percent turnover rate, true blue managers buy, hold, and suffer the near-term slings and arrows. But what matters more to you and me is which funds have withstood the test of time -- and these testy times for value investors.

One fund that has long earned my respect is Oakmark (OAKMX), but with this week's stunning departure of its manager Bob Sanborn, I think there's little value left in the fund. A worthy substitute is the Tweedy, Browne American Value (TWEBX). In the musical chairs world of the fund industry, heading a portfolio for 15 years is tantamount to having been there forever. In classic value investing fashion, this fund has delivered some goods (it was up 2 percent last year -- so cash was a better alternative). But relative to its value peers, which were actively losing you money, Tweedy, Browne American Value stood tall.

Dodge & Cox Stock (DODGX) concentrates on blue-chip companies that have fallen from marketplace favor. The fund got its start back in 1965. Besides having a laudably low expense ratio of 0.6%, Dodge and Cox has an annual turnover of about 10%. Management strategy focuses on buying underpriced blue-chip companies like GM (NYSE: GM), Citicorp (NYSE: C), Dow Chemical (NYSE: DOW), and American Express (NYSE: AXP).

And the Winner Is...

My No. 1 pick is Fidelity Dividend Growth (FDGFX). The portfolio is heavily oriented toward large-cap companies and holds a blend of value and growth stocks, leaning toward value (despite the name, fund performance is driven by capital gains, not dividend income). Unlike most of his colleagues in Fidelity's growth fund area, manager Charles Mangum was not wedded to technology last year -- the direct result of his focus on valuations -- which led to an unhappy marriage with the market. Mangum instead favored the financial and health care sectors. He still does.

That's not to say that Mangum has been afraid to make bets on his favorite stocks; his top 10 holdings accounted for 35.3 percent of assets at the end of last year -- placing him among the more ardent believers in his top 10 stocks. Mangum's convictions have a history of paying off handsomely. I'm watching him closely in 2000 to see if he is going to be flexible or stubborn in the face of new market realities. While 1999 gave the fund a rough ride (its return was less than half that of the S&P 500), Mangum remains one of my favorite managers. I continue to believe that the fund's low volatility and blue chip holdings, and Mangum's superior stock picking, make Dividend Growth an ideal candidate as a core holding in most investors' portfolios. (I also believe you should complement this position with Fidelity Growth Company -- FDGRX.)

The Bottom Line

Each of the above funds could serve as solid defense with significant upside potential. That's a good mix, especially in light of today's divergent, growth-driven market. But I wouldn't, as suggested by my Growth Co fund comment above, lump everything into a value fund. Instead, I'd use the fund to help offset the risks of an existing go-for-growth portfolio. Doing so will give you a hybrid of the "I made a killing" mantra. You'll be able to sidle up to the bar real casual like and say to your pals, "I didn't get killed." And for once, you can buy the next round without wondering if you'll have to sell some growth fund shares to afford it.

-- Posted: March 27, 2000