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You won't find these stocks on anyone's hot list

Where have all the bargains gone?

Investors have picked them every one.

Pete Seeger had his eye on bigger themes than the stock market when he wrote Where Have All the Flowers Gone , but what a great summary of the investor's plight today. The stock markets are way up, and the opportunities to buy low-priced stocks are few.

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So how about calling in the bargain-hunting experts to help? They're called value investors and they use an approach to stock picking that was developed by Benjamin Graham in the 1930s and later popularized by Warren Buffett, and that is now available to retail investors through a variety of mutual funds and exchange-traded funds.

Value investing means buying cheaply priced stocks and then waiting for everyone else to follow along. Among those who feel this is the right approach today is Eric Kirzner, who holds the John H. Watson Chair in Value Investing at the University of Toronto's Rotman School of Management.

"The markets have had a huge bounce, bigger than anybody would have anticipated, and many stocks have moved close to their precrash levels," Prof. Kirzner said. "This is now a stock picker's market."



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While there are numerous splinter groups and subsets, the business of picking stocks breaks into two camps. There's value and there's growth, which keys on companies with fast-growing revenues and profits. Growth had its moments in the last phase of the bull market that died in 2008, but value's been the much better performer since then. Should investors stick with it?

"Absolutely," Prof. Kirzner said. "The value approach would be the one to use right now."

Not all value adherents are that enthusiastic. Francis Chou, one of Canada's most respected value investors, recently warned clients in his 2009 annual report that he's having trouble finding bargain-priced stocks to buy, and that stock market risk has risen over the past year.

But other value managers say they continue to find stocks to add their portfolios. "Clearly, it's not as attractive as it was out there," said Jeffrey Stacey, partner at Stacey Muirhead Capital Management in Waterloo, Ont. "But I do not think prices are excessive yet."

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Within the value camp, there are so-called deep value managers who will on occasion buy into companies of lesser quality provided they're available on the cheap, and others like Mr. Stacey who seek quality companies at bargain prices.

"We try to buy as cheaply as we can," he said. "But, as the Buffett quote goes, we'd rather pay a fair price for a wonderful business than a wonderful price for a fair business."



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Mr. Stacey said the stocks his firm owns include Nike, Indigo Books & Music and Fairfax Financial, a financial holding company that is itself run by a respected value investor, Prem Watsa.

Indigo remains a value stock in Mr. Stacey's eyes, even though it has risen to about $18 from just under $11 a year ago. He said the company has a clean balance sheet, growing sales, roughly $5 a share in excess cash and, based on expected earnings, it has a price/earnings ratio of about 10.

Prof. Kirzner's take on value stocks focuses mainly on such mainstream, bricks-and-mortar names as Coca-Cola, General Electric and BCE. "You're really buying the economy," he said.

Value investors use different methods of finding low-priced stocks, but the most basic measure is a low price/earnings ratio, which shows how expensive a stock is in comparison to its earnings per share. Value investors go for low P/E stocks, growth investors for high P/E stocks. One expert said the threshold for value is a PE under 15.

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Prof. Kirzner said that over the long term, value stocks - that would be low P/E stocks - have outperformed higher P/E growth stocks by three percentage points. Every so often, however, growth investing does take the lead.

An example would be in the late stages of a bull market, said George Athanassakos, a finance professor who holds the Ben Graham Chair in Value Investing at the University of Western Ontario's Richard Ivey School of Business.

"At the bottom of the cycle and early on, value beats growth," Prof. Athanassakos said. "But then, as the economy starts to overheat, then growth starts to beat value."

In fact, value is pulverizing growth right now if you judge the comparative returns of a pair of ETFs that put growth and value spins on the Canadian market. The iShares CDN Growth Index Fund and the iShares CDN Value Index Fund. The growth ETF made almost 49 per cent for the year through Thursday, while the growth ETF made a little less than 19 per cent. The growth ETF's cumulative three-year number is better, which is a reflection of its outperformance prior to the crash.

Mr. Chou's family of value funds has also done well lately. His two biggest funds, Chou Associates and Chou RRSP, are both among the leaders in their categories with 12-month returns of 45.7 per cent and 54 per cent, respectively. He's warning investors not to expect more of the same, though.

"Now, your mind goes back to safeguarding capital," Mr. Chou said. "As a value investor, you're always conscious of the downside."

Value investing is sometimes considered a safer, more conservative way of investing because of the margin of safety you get when you buy stocks at much less than you figure they're truly worth. But many value funds, particularly those in the deep value category, where thrashed in 2008.

The results at Mr. Stacey's firm, where the focus is on top-quality companies, suggest you can expect a somewhat smoother ride with blue-chip value investing. Audited annual results for Stacy Muirhead's limited partnership portfolio show two down years since 1994, including a drop of 22.2 per cent in 2008. The S&P/TSX composite index fell five times over that period, including a 33-per-cent plunge in 2008.

What all value funds have in common is an emphasis on buying stocks that you won't find on anyone's hot list. That's an approach that makes sense after the huge gains of the past year.

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Where The Value Is

With the markets coming off huge gains in the past year, it makes sense to consider a bargain-hunting approach called value investing. Here are some stocks, exchange-traded funds and mutual funds of interest.

Stocks

Benjamin Graham is the father of value investing, and Warren Buffett popularized it. What value stocks might they like right now? We asked Validea, a stock research service that replicates the style of several top investing gurus, for some ideas.

Canadian stocks that Graham or Buffett might like

Ticker

One-Year % Return

Precision Drilling Trust

PD.UN

96.30%

Harry Winston Diamond

HW

213%

Domtar Corp.

UFS

355.40%

Sierra Wireless

SW

76.90%

Northgate Minerals Corp.

NGX

95.60%

Cameco Corp.

CCO

25.50%

EnCana Corp.

ECA

11.50%

Gildan Activewear

GIL

152.20%

U.S. stocks that Benjamin Graham might like

Northwest Pipe Co.

NWPX

-23.20%

Tidewater Inc.

TDW

24.70%

National-Oilwell Varco

NOV

36.30%

Daktronics Inc.

DAKT

0.10%

Ensco PLC

ESV

71.10%

Spartan Motors Inc.

SPAR

11.80%

Noble Corp.

NE

66%

U.S. stocks that Warren Buffett might like

Apollo Group Inc.

APOL

0.10%

World Acceptance Corp.

WRLD

107%

The TJX Companies Inc.

TJX

67.90%

Ross Stores Inc.

ROST

48.20%

Coach Inc.

COH

129.30%

Varian Medical Systems

VAR

74.90%

Stryker Corp.

SYK

66.20%

Aeropostale Inc.

ARO

67.80%

ITT Educational Services Inc.

ESI

26.30%

ETFs

These TSX-listed ETFs use variations of the value strategy

Ticker

One-Year % Return

iShares CDN Value Index Fund

XCV

48.70%

Claymore Canadian Fundamental Index ETF

CRQ

49%

Claymore U.S. Fundamental Index ETF - C$ Hedged

CLU

61.70%

Claymore International Fundamental Index ETF

CIE

21.30%

Funds

Here's a selection of mutual funds that to varying extents use a value investing approach. They all appear on the list of top picks by analysts and the independent fund research firm Morningstar Canada

Min. Investment

One-Year % Return

Chou Associates

$5,000

45.70%

Mackenzie Cundill Canadian Security C

$500

48.60%

Leith Wheeler Canadian Equity B

$5,000

51.70%

Mackenzie Cundill Value C

$500

32%

Beutel Goodman Canadian Equity

$10,000

44.20%

Mutual Discovery

$500

18%

Brandes Sionna Canadian Equity

$1,000

29.90%

Brandes Global Equity

$1,000

19.50%

Notes:

~ The Canadian Buffett and Graham favourites were drawn from among Canadian stocks that are listed on the NYSE

~One-year stock and ETF returns are to April 8, fund returns to Feb. 28

~The minimum $5,000 purchase for Leith Wheeler Canadian Equity applies on investments made through third parties like discount brokers; otherwise the minimum is $25,000

Source: Validea, globeinvestor, Morningstar.ca

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About the Author
Personal Finance Columnist

Rob Carrick has been writing about personal finance, business and economics for close to 20 years. He joined The Globe and Mail in late 1996 as an investment reporter and has been personal finance columnist since November 1998.Rob's personal finance columns appear in The Globe on Tuesday and Thursday, and his Portfolio Strategy column for investors appears on Saturday. More

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