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Three value stock picks from the worst-performing sectors

There are sectors that haven’t been able to keep up, and that’s where the true values for investors are likely to be found.

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John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.

If global economic growth predictions come true, stocks could continue their climb into the stratosphere.

It almost seems impossible at this point, but every day there are signs this bull still has room to run, despite a steady drumbeat of warnings that it is about to end and Thursday's ominous 30-year anniversary of the 1987 crash.

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Around the world, central banks are shifting gears on easier money policies that were needed during the financial crisis and its aftermath but are no longer as necessary. This is happening as economic output begins to climb, a sure sign of growth. And the promise of government spending and corporate tax cuts in the United States, combined with strong earnings reports, has lifted shares this year.

The S&P 500 index is now up more than 14 per cent for the year and the Dow Jones industrial average busted through the 23,000 mark. But naturally, there are sectors that haven't been able to keep up, and that's where the true values for investors are likely to be found.

Take telecommunications. While information technology has grabbed all the attention – in the form of flashy technology stocks such as Apple, Alphabet and Netflix – telecommunications stocks have fared the worst of any of the index's 11 sectors, down more than 12 per cent year-to-date. The sector includes AT&T, CenturyLink and Verizon.

Energy has also been beaten down nearly 9 per cent. While consumer staples stocks are up 5 per cent, they have struggled to climb into the double-digits like the other sectors.

These are the three worst-performing sectors of the broad market index. What is holding them back? These stocks aren't necessarily poised to benefit from what's known as the reflation trade – a bet on global growth and economic revival – that is lifting shares of financials, materials and health-care stocks.

An even bigger point: They aren't shares of companies in the glamorous tech industry, where many investors have flocked to bet on growth.

Instead these are value plays in industries that are struggling with new competitive pressures and shifting consumer preferences. In telecommunications, wireless carriers are battling to upgrade to newer and faster networks while trying to entice consumers who are cutting ties with traditional cable and internet bundles. There is also a fair amount of merger speculation among carriers, and concerns whether any potential deals would get past antitrust scrutiny.

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Energy has been tricky sector for even the savviest of investors. The push-pull of $50 (U.S.) a barrel oil has created disruptions for everyone from the giant producers to the oil field services firms and other companies connected to the oil business.

Consumer staples, filled with names of packaged food and beverage companies, as well as grocers and other retailers that sell those products, have also been hammered by the "Amazon effect." The e-commerce giant has caused a tidal wave of angst among companies involved in the distribution of consumer goods, creating winners and losers in the real world of stores, supply chains and brand names.

So far, as analysts have pointed out, the winners this year have been led by the growth-oriented stocks, and value has struggled to keep up.

Value investors may have begun their hunting for the season, however. In the more recent three-month period, telecom is up 3 per cent, while energy is up 5 per cent and consumer staples are breaking even.

At Validea, we have created model portfolios based on the investment strategies of some of history's most successful stock pickers, and many of them use an approach that hunts for value. Here are some picks from among the market's worst sectors.

CVS Health Corp. (CVS)

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You can go down the list of beaten-down retail operators, but CVS, the retail pharmacy and health-care company, may have some promise for value investors. The stock trades around $74, down from a 52-week high of $88, and three of my models, including the model based on Joel Greenblatt's Magic Formula, rank the stock highly. Mr. Greenblatt, an author and successful money manager, developed a two-step value approach looking for firms with high earnings yields and high returns on capital. CVS is the 28th highest scoring name in the U.S. market based on the combination of earnings yield and return on capital.

AT&T Inc. (T)

This telecommunications giant fits the investing portfolio tracking the style of James O'Shaughnessy, an investor who uses quantitative analysis to find mispriced stocks. Shares of AT&T are down 15 per cent this year near a 52-week low, and investors may be more attracted to it for the hefty 5.4 per cent dividend. The stock could get a boost, however, if the deal for Time Warner finally makes it through antitrust scrutiny.

Frontline Ltd. (FRO)

Finally, in the energy sector, Frontline is in the business of shipping oil and petroleum products. It fits the model tracking James Piotroski, an accounting professor who developed and tested a model that combined a value component with account-based improvement metrics. Some of the criteria the model flags are a high book-to-price ratio (i.e. a low valuation) and gross margins that are expanding year over year rather than contracting. The shares of Frontline are down 16 per cent year-to-date, but over the past month they are up more than 10 per cent.

After a long slumber for value, investors may be finally waking up to this group of unloved, discounted names.

Should you be investing in ETFs or mutual funds? Rob Carrick, personal finance columnist, lays out specific investments, services and brands that are currently great deals for Canadian investors.
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