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Deep Dive: Small-cap worth shares look low-cost even after an enormous rally, say two fund managers

Value stocks have suffered a rift in the past six months as some growth stocks defaulted. According to two fund managers from different companies that hold small-cap and mid-cap stocks, value creation may still be early on.

Justin Tugman of Janus Henderson Investors and Christian Stadlinger of Columbia Threadneedle Investments both argued that the appreciation will continue, especially for small-cap and mid-cap companies. The two mutual fund managers highlighted stocks that are still attractively priced.

At the end of this article, you'll find tables and graphs that show how the price / earnings ratio of small- and mid-cap stocks has not risen as much as that of the broad S&P indices and their growth subsets.

Tugman is a co-administrator of the Janus Henderson Small Cap Value Fund
JSCOX,
-2.14%
together with Craig Kempler and Co-Manager of the Janus Henderson Mid Cap Value Fund
JMVAX,
-0.92%
with Kevin Preloger. The Small Cap Value Fund is rated four (out of five) stars by Morningstar, while the Mid Cap Value Fund is rated three stars.

Discussing the broad market rally since the pandemic bottomed out in March 2020, Tugman said the unprecedented monetary and fiscal stimulus has led some investors to "suspect all common sense about valuation metrics"

After a long period of growth stocks outperforming, he believes that investor expectations of a fast-growing US economy and rising interest rates will continue to bode well for value stocks. He noted that historically, the periods of outperformance for value stocks have spanned several years.

Tugman said he and his colleagues are more "risk averse". When choosing new stocks for the portfolios they manage, they first consider downside risk, then focus on upside and create a risk / reward ratio. You avoid highly indebted or unprofitable companies and those facing "binary events" such as: B. Biotechnology developers doing experiments.

Tugman named three value stocks he thinks are attractive today:

Citizens Financial Group Inc.
CFG,
-3.64%
of Providence, R.I., is a regional bank with assets of $ 183 billion and approximately 1,000 branches in 11 states. Tugman described the stock's valuation as "attractive at about 11 times its estimated 2021 earnings". He said the bank's credit quality is strong and it is well positioned to benefit from the steeper yield curve. Citizens is one of the largest holdings in the Janus Henderson Mid Cap Value Fund.

United Community Banks Inc.
UCBI,
-3.67%
is a participation of the Janus Henderson Small Cap Value Fund. Based in Blairsville, Georgia, the company has total assets of $ 17.8 billion and offices in five states. The stock has a forward P / E of 14.8, which is on the high side for a bank. "We don't think the valuation is egregious for a bank that is growing as it is," said Tugman. He believes UCBI will continue to grow its loan portfolio in the high single digits, which is an impressive organic growth rate for any bank.

Another small-cap investment is Sunstone Hotel Investors Inc.
SHO,
-1.81%,
This is a real estate investment trust that owns and rents hotel buildings to operators licensed by Marriott, Hilton, and other well-known brands. Tugman said hotel closings during the pandemic caused a "cash burn" but Sunstone's balance sheet was still healthy. With the reopening of the industry, he believes that “SHO is well positioned for the long term”.

Stadlinger is the lead manager for the Columbia Small Cap Value Fund II
NSVAX,
-2.54%,
Jarl Ginsberg is co-manager of the fund, which is rated four stars by Morningstar.

In an interview, Stadlinger said that small-cap growth stocks had outperformed value for 10 years through 2019 because "when growth is scarce, the market pays more for growth." He was referring to slow GDP Growth in the US. The economists surveyed by MarketWatch now expect a GDP growth rate of 6% for 2021.

“(T) Much more money is being spent here. In this case, value stocks have done better in the past, ”he said.

The Columbia Small Cap Value Fund II holds approximately 100 stocks. Stadlinger said he and Ginsberg pick value stocks that they believe will become growth stocks as companies' earnings improve. "This is how you get returns," he said.

Among the companies owned by the Fund that Stadlinger expects to move from value to growth is Sunstone Hotel Investors, also owned by Janus Henderson and described above. "All indicators are positive" for the company as the industry reopens in full force, he said.

Four other companies mentioned by Stadlinger:

Herc Holdings Inc.
HRI,
-4.94%
rents construction and earthmoving machinery. As the economy improves, "capacity utilization increases quite a bit," said Stadlinger. The company is based in Florida and primarily operates in southern states, where commercial and residential construction activity is strong. And Stadlinger considers a large round of federal infrastructure spending to be “feasible”.

Marriott Vacations Worldwide Corp.
VAC,
-0.94%
is a timeshare operator. This is an industry whose business model has changed for at least such a large player. When you own a timeshare with Marriott Vacations, you'll earn points that you can use to interact with other company-operated timeshare properties. Stadlinger said that unlike hotel operators, timeshare companies continued to charge maintenance fees from most customers during the pandemic. So they were undervalued. And now as the travel industry reopens, various other sources of income are picking up again, including restaurant and pool fees, he said.

Atlantic Union Bankshares Corp.
AUB,
-4.00%
Headquartered in Richmond, Virginia, with $ 19.6 billion in assets and 129 offices in three states. Stadllinger called AUB the "largest independent bank in Virginia" with "very strong management" and good prospects for credit growth if the economy improves. He also believes the bank is a take-out target for J.P. Morgan Chase & Co. is.
JPM,
-1.55%
or Bank of America Corp.
BAC,
-0.96%
if they want an expanded presence in the state.

Ultra Clean Holdings Inc.
UCTT,
-5.27%
manufactures chemicals and equipment used by semiconductor manufacturers. The stock trades for 15.9 times the consensus earnings estimate among analysts surveyed by FactSet. Stadlinger called UCTT "cheap" because of the growth prospects in its industry. The chip manufacturing business is booming.

Value versus growth

The broad stock market indices are divided into overlapping value and growth groups. The value groups are larger and the companies in them tend to have lower value for money and price-to-book ratios and lower sales growth rates. The growth groups tend to have higher price valuations and higher growth rates. The companies in both camps have characteristics of both, or at least the last time the indexes were adjusted, which happens annually.

Here are the total returns for the three broad S&P indices over the past six months, as well as those of their value and growth subgroups:

(FactSet)

The value groups were at the top of all three indices in the last six months, as the shares performed very well across the board.

However, a long-term look at the price-earnings scores for exchange-traded funds that the groups track reveals a notable trend: for mid- and small-cap stocks, P / E scores for the value groups still appear relatively low.

Let's first look at the large caps – this is the SPDR S&P 500 ETF Trust
SPY,
-0.05%,
the iShares S&P 500 Value ETF
I HAVE,
-0.26%
and the SPDR Portfolio S&P 500 Growth ETF
SPYG,
+ 0.09%
::

(FactSet)

P / E valuations are consistently high for large caps, but less so for value.

For mid-caps, you can find P / E comparisons for the iShares Core S&P mid-cap ETF here
IJH,
-1.82%,
the SPDR S & P 400 Mid Cap Value ETF
MDYV,
-1.76%
and the iShares S&P 500 Mid-Cap 400 Growth ETF
IJK,
-1.89%
::

(FactSet)

For small cap stocks, you can find P / E comparisons for the SPDR S&P 600 Small Cap ETF here
SMART,
-2.43%,
the iShares S&P Small-Cap 600 Value ETF
IJS,
-2.59%
and the Small Cap Growth ETF SPDR S & P 600
SLYG,
-2.42%
::

(FactSet)

Therefore, the forward P / E ratios for small- and mid-cap stocks are not very high compared to 10-year averages even after such a strong rally.

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