Here’s a powerful argument for favoring value stocks over growth stocks


Ernesto Ramos of BMO Global Asset Management helps manage funds that follow value and growth strategies. He says value may soon win out over growth after years of underperformance.

Growth stocks, helped by yearslong ultra-low interest rates and a growing economy, are trading high relative to value stocks based on historical price-to-earnings ratios. Investors’ favored growth stocks include Apple Inc.

AAPL, +2.32%

AMZN, +1.03%

 and Alphabet Inc.

GOOG, +1.96%

GOOGL, +2.18%

“But eventually all these trends will revert,” he said in an interview April 26. “ ‘Eventually’ might mean a couple of weeks, a couple of months, a couple quarters. But if you are patient, you will be rewarded.”

The Russell 1000 Index

RUI, +0.25%

 is made up of the largest 1,000 U.S. stocks by market capitalization. It is divided into the Russell 1000 Value Index

RLV, -0.14%

which includes the components with lower price-to-book ratios and slower earnings growth rates, and the Russell 1000 Growth Index

RLG, +0.61%

which includes companies with higher price-to-book ratios and faster expected earnings growth rates.

Here’s how the growth and value indexes have performed over the past 10 years:


You can see that the growth index’s superior performance has accelerated in recent years.

The Russell 1000 Growth Index has risen an average of 12.8% a year in the past three years, easily surpassing the Russell 1000 Value Index’s 7.7% gain. The outperformance has, so far, continued into 2018. (See the table at the bottom of this story for more details.)

But Ramos, the head of equities for BMO Global Asset Management and portfolio manager of the BMO Large-Cap Value Fund

MLVIX, -0.19%

 and the BMO Large-Cap Growth Fund

MLCIX, +0.65%

said he expected the trend to reverse because investors are paying too high a price for growth stocks.

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Growth stocks, excluding the effects of the Trump tax cuts, are valued at 20 times earnings for 2018 and 17.8 times earnings for 2019, Ramos said. As for value, the figures are 14.9 and 13.7, respectively.

Earnings for the Russell 1000 Growth Index are expected to increase 30.9% this year (including the benefit from the tax cut that Ramos estimates to be 10% to 12%) and another 12.6% in 2019, he said. For the Russell 1000 Value Index, earnings are expected to increase 28.2% this year and 8.9% in 2019.

It’s normal for growth stocks to trade at higher valuations than value stocks, but, according to Ramos, “the spread between growth and value valuations has not been this high for 10 years.”

“They are both expected to show strong earnings growth,” he said. “They are not that dissimilar, so that should not justify such a big valuation potential.”

Value favorites

Ramos said United Rentals

URI, -0.91%

and Citigroup

C, -0.03%

 are good examples of value stocks that are attractive now. Both are held by the BMO Large-Cap Value Fund

BALVX, -0.25%

He likes United Rentals

URI, -0.91%

because its tremendous presence in the equipment rental industry gives it competitive advantages that include “more purchasing leverage, a wider range of equipment and services, and the convenient movement of assets between locations.” Analysts expect the company’s earnings to increase by 43% (again, factoring in the tax cuts) in 2018 and another 12% in 2019.

Ramos touted United Rentals’ return on equity of 59%, underlining its status as a “very profitable” company. Meanwhile, “it trades cheaply” at 9.8 times estimated earnings for 2018, he said.

The fund manager expects Citigroup to benefit from higher trading revenue because of increased stock-market volatility and expanded net interest margins as rates rise. The fund holds shares of Wells Fargo

WFC, +1.15%

 and Bank of America

BAC, +0.10%

 as well.

Here are the top 10 holdings (of 72) of the $362 million BMO Large-Cap Value Fund as of March 31:

Company Ticker Share of fund Total return – 2018 through April 30 Total return – 2017 Total return – 3 years Total return – 5 years Total return – 10 years
Bank of America Corp.

BAC, +0.10%

4.3% 2% 36% 96% 157% -9%
Chevron Corp.

CVX, -0.20%

3.6% 1% 11% 28% 25% 88%
Pfizer Inc.

PFE, -3.31%

3.6% 2% 16% 20% 50% 174%
Citigroup Inc.

C, -0.03%

3.3% -8% 27% 32% 51% -71%
Walmart Inc.

WMT, -1.19%

2.8% -10% 47% 23% 30% 95%
Exelon Corp.

EXC, +1.18%

2.3% 2% 15% 31% 28% -29%
Valero Energy Corp.

VLO, -0.19%

2.2% 22% 40% 118% 251% 220%
Bristol-Myers Squibb Co.

BMY, +1.07%

2.2% -14% 8% -12% 50% 244%
Cisco Systems Inc.

CSCO, +1.22%

2.2% 17% 31% 70% 149% 112%
American Electric Power Co.

AEP, -0.77%

2.1% -4% 21% 37% 64% 142%
Sources: BMO Mutual Funds, FactSet
Track records for two BMO funds

Ramos co-manages the BMO Large-Cap Value Fund and the BMO Large-Cap Growth Fund. Both funds have multiple share classes. Ramos said sales charges for class A shares are waived for the “overwhelming majority” of investors who buy them directly from BMO Mutual Funds, through brokerage accounts with Schwab, Fidelity or others, and through advisers. Annual expenses of 0.8% of assets under management for the value fund and 0.79% for the growth fund are considered “low” by Morningstar.

Here’s how both actively managed funds’ class A shares have performed against their benchmarks and Morningstar categories:

Total return – 2018 through April 30 Average return – 3 years Average return – 5 years Average return – 10 years
BMO Large-Cap Value – Class A

BALVX, -0.25%

-2.5% 7.8% 11.1% 6.7%
Russell 1000 Value Index -2.5% 7.7% 10.5% 7.3%
Morningstar Large Value category -2.0% 7.4% 10.0% 7.3%
Sources: Morningstar Direct, FactSet
Total return – 2018 through April 30 Average return – 3 years Average return – 5 years Average return – 10 years
BMO Large-Cap Growth – Class A

BALGX, +0.66%

1.8% 13.2% 15.8% 10.1%
Russell 1000 Growth Index 1.8% 12.8% 15.1% 10.8%
Morningstar Large Growth category 2.9% 10.8% 13.6% 9.2%
Sources: Morningstar Direct, FactSet

Source : MTV