The Potential Role of Value Investing in Volatile Markets

March 15, 2010

The Potential Role of Value Investing In Volatile Markets

Provided by,

Lynn M. Magner, CFP®

Vice President - Investments

UBS Financial Services Inc.

(262) 794-0814



The inclusion of stocks in a portfolio is essential to pursuing most financial goals, because stocks historically have outperformed all types of bonds and cash alternatives over the long term, and their higher returns help combat inflation. Sharp price swings in stocks that can arise due to market volatility, however, can cause even some of the most disciplined investors to turn jittery and unload their portfolios. In a turbulent market environment, suitable investors looking for the capital appreciation potential that stocks provide – with a lower level of volatility than other types of stocks – often find value stocks appealing.


Value stocks are those that are perceived to be “bargains” or are undervalued – that is, those whose true values are not reflected in their current prices and, over time, whose prices are estimated by value managers to potentially increase faster than stocks that are fully priced. Value stocks may be inexpensive or “cheap” compared to what they are currently worth. The market is not willing to pay more for them because their underlying companies or industries are out of favor. The job of value investment managers is to identify companies poised for a possible turnaround, potentially leading to rising earnings and opportunities for higher stock prices.


Before an investment manager identifies a value stock as a “buy,” they need to determine if a positive change has occurred in the underlying company that is yet to materialize in the stock’s current price. Positive changes include:

• an aggressive management change or significant productivity improvements;

• a restructuring to reduce costs, which would make the company more likely to continue pursuing profitability over the long term; and

• financial conditions that they believe are strong or improving.


Value managers generally use a “buy and hold” strategy. This means that a stock will be held until it meets its target price (of course, there is no assurance that target prices will be attained), and in some cases, even longer if the underlying company demonstrates the potential for continued profitability. Value managers will sell stocks that appear overvalued or have experienced deteriorating fundamentals.


Large company value stocks typically are more attractive than small company value stocks during times of market volatility because these stocks are often from companies that are established market or industry leaders. They therefore generally withstand market setbacks better than small cap stocks and experience smaller price swings during market volatility.


Of course, like all stocks, large company value stocks are subject to market risk and will undergo fluctuations in stock prices; downward (as well as upward) trends can occur over short or extended periods.


Dividends Can Potentially Add a Level of Protection in Turbulent Times

In addition to capital appreciation, value stocks typically pay investors a steady stream of income through dividends, although dividends are not guaranteed. Dividends provide:

• Cash Return to the Investor – Dividends are a major reason to invest in stocks at any point in the stock market cycle. Stocks that pay attractive dividends are appealing because they offer the potential for above-average growth of investment capital and steady income.

• Downside “Cushion” – High current dividend yields of underlying companies can serve as a “cushion” for companies’ share prices if they temporarily fall out of favor with the market. This plays an even more important role in volatile or declining markets.

• Favorable Tax Treatment – The Tax Increase Prevention and Reconciliation Act of 2006 extends favorable capital gains tax rates to certain dividends. Through 2010, those investors in the 25 percent or higher tax bracket pay 15 percent on qualified dividend income, instead of the investor’s ordinary income tax rate.


Value Stocks in Your Overall Investment Plan

Value stocks are especially appealing in turbulent times because they tend to be more defensive than other equity styles. That is why many conservative investors, investors nearing retirement and first-time stock investors have found them so attractive. They enable investors to participate in the potentially larger gains associated with stocks while helping to manage risk in a diversified portfolio.


Value stocks can play an important role in an investor’s portfolio. Selecting those stocks appropriate for your investment plan, however, is a demanding process that requires the inclination and time to analyze companies, study the forces that influence the economy, and assess the trends in the financial markets. In volatile markets, this challenge can prove even more daunting.


A professional investment management program may be an appropriate strategy for building a portfolio of value stocks. Your financial advisor can help you determine if investing in value stocks through separately managed accounts is suitable for your specific situation, in light of your risk tolerance, investment objectives, and liquidity needs. For more information about how you can diversify your portfolio with value stocks, and information about other defensive investment strategies that may be appropriate in a volatile market environment, please contact your financial advisor.

The information contained in this article is based on sources believed reliable, but its accuracy cannot be guaranteed. This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial advisor, as well as your tax and/or legal advisors regarding your personal circumstances before making investment decisions.

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