We’re All Value Investors Now. Here’s How to Play It.

Articles From: Barron's
Website: Barron's

By:

Chief Strategist

Interactive Brokers

Rumors of the death of value investing, fueled by the spectacular outperformance of growth stocks during the recent bull market, have proved to be premature. Since the lows of March 2020, the performance of the S&P 500 Value index is now almost identical to that of its Growth index counterpart.

One might say that the value-stock tortoise has caught the growth-stock hare. Yet it would be equally premature to give up on growth stocks altogether. This year’s selloff has resulted in various growth names trading at attractive valuations. In other words, they’re now value stocks. Investors can use options to capture the values that some fallen growth stocks might be offering.

For most of the past two years, growth stocks were shooting higher as new and experienced investors alike pursued popular names with little regard for valuation metrics—until it came to a grinding halt. Many Covid-era darlings fell 50% to 90% off their recent all-time highs. Some of these stocks deserved their fate, while others have been unfairly discounted. The problem is figuring out which is which.

Broadcom (ticker: AVGO) gave us a road map when it agreed to purchase VMware (VMW) in late May. One growth company bought another at a value price. VMware, a cloud-computing and virtualization company, has been steadily profitable and cash-flow positive for over a decade, though neither measure has been growing at a rapid rate. It is a solid company in an increasingly necessary tech niche whose forward price/earnings ratio had fallen into the midteens before the deal was announced. Most important, VMware’s P/E-to-growth, or PEG, ratio had fallen to just above one.

A PEG ratio of one or less is traditionally considered the mark of a fairly valued or inexpensive stock. It is a crucial metric because it offers a way to normalize disparate P/E ratios. A fast-growing company probably sports a higher P/E than a slower-growing peer, and the PEG helps tell us which P/E is a more accurate reflection of a company’s growth rates.

Individual investors are not in a position to make strategic acquisitions of large tech companies, but anyone can employ an acquirer’s rationale. Consider a stock like Qualcomm (QCOM). With a market capitalization over $150 billion, it is unlikely to be a takeover target, but like VMware, this semiconductor stock has a long track record of both profitability and positive cash flow. It sports a current P/E under 15, a forward P/E under 12, and a PEG ratio under one.

Well-capitalized investors can write cash-secured put options to garner income while waiting for a stock to reach a desired entry point. Over the past two weeks, Qualcomm has traded in a roughly $125 to $144 range. Risk-tolerant traders who are willing to buy the stock at a discount to its recent $140.02 price could consider selling the $135 puts expiring on June 10 at $1.75.

If Qualcomm stays above $135, traders should be prepared to roll their puts into the next week’s expiration. If the stock falls below that strike, they must be prepared to buy shares at $135, giving them a break-even of $133.25. In that case, the traders can decide whether to hold on to the shares as an investment or write covered calls above the market for income.

My preference is to write short-dated options rather than longer-dated ones. Short-term options realize less initial premium and require more maintenance, but they decay more quickly. That offers the potential for an options writer to reap more revenue over the same period.

All too often, we think of investing in terms of stock and option strategies, but we are ultimately focused on the underlying companies. Someone who remembers how to spot value, and who has the skill to curate positions with options, just might have an edge in a difficult market.

Originally Posted June 2, 2022 – We’re All Value Investors Now. Here’s How to Play It.

Steve Sosnick is the chief strategist at Interactive Brokers.

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