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2013 looks to be a good year for wise investors to favour value stocks

In the mercurial world of stock market trends, predicting whether the market is favouring growth or value styles is an either/or situation.

In the mercurial world of stock market trends, predicting whether the market is favouring growth or value styles is an either/or situation.

Sometimes growth stocks, which tend to produce consistently higher earnings, dominate. Then they fall out of favour, as value stocks, bought at bargain prices relative to their potential market value, take the limelight.

The nature of the beast in the growth versus value tug of war is that when big-money managers conclude that growth stocks may be getting overpriced then it is time to look for bargains.

Since institutions tend to move in a herd, a switch en masse happens almost simultaneously and billions flow into bargain-priced stocks over a period of months. Sometimes the buying lasts for years.

Indeed, the value shift appears to have gained some ground year-to-date through February 15, as the value ledger of the Standard & Poor's 500 rose 7.3 per cent compared to 5.4 per cent for growth stocks, S&P reports.

"We do think that this is a trend that could have legs," says Todd Rosenbluth, director of mutual fund research for S&P Capital IQ, a market research company based in New York. "But it's still early in 2013."

The last major value cycle ran roughly between 2001 and 2008. That was after the dot-com implosion and recession of 2001, when growth stocks largely crashed and burnt after the manic tech-bubble run of 1998 to 2001. In the recovery from the 2008 meltdown, though, growth stocks have largely dominated, as companies rebuilt their earnings streams.

Although you can make money in either market phase, the value cycle might benefit you better because it tends to step away from stocks that can be overvalued and due for declines. Unlike growth stocks near the peak of their popularity, value stocks often offer more upside potential.

Sometimes popular growth stocks such as Apple are burdened with unrealistic expectations and any disappointment in news or earnings leads to a sell-off. Since hitting a 52-week high of US$705 (Dh2,589) last September, for example, Apple stock has seen a precipitous decline and has been trading under $500 of late.

While short-term trends can be misleading, some recent evidence points to a value upsurge. Large-cap value funds, according to Lipper, a Thomson Reuters company, gained 17 per cent for the one-year period through January 31. That compares with 16.8 per cent for the S&P 500 Index and 13.3 per cent for large-cap growth funds.

It could be that the recent value returns are driven by heavy weightings in the financial sector, underdogs in recent years that experienced a comeback last year and rose more than 24 per cent as a group. Or, maybe the tide is turning and large institutions are making a shift toward value investing.

Although no one really knows when a cycle makes a turn in real time - it is best to make this call through the rear-view mirror - consistently investing in value offers a way to grab bargain-priced stocks with slightly lower volatility and higher dividends than their growth cousins.

In considering value stocks, it makes sense to diversify across countries and the size of companies: large-, mid- and small caps. Index funds generally give you the broadest array.

For large companies, the Vanguard S&P 500 Value ETF, invests in more than 350 stocks found in the S&P 500 Value Index. It is also a good way to own the company run by Warren Buffett, Berkshire Hathaway, which is a living testament to value investing; the fund has a 2.6-per cent stake in the company. The Vanguard fund was up nearly 20 per cent for the year through January 30.

Vanguard also has a Mid-cap Value ETF that tracks the MSCI US Midcap Value Index and holds companies such as Mattel Inc and Seagate Technology PLC. It was up 18 per cent over the same period.

By employing a balanced approach, you could split the difference between growth and value funds - 50 per cent each - or simply buy a fund that tracks an index with a larger number of stocks in it.

* Reuters