The Store Is Open for Value Buyers

Last week's selloff left a lot of frayed nerves on Wall Street. But several value managers see bargains everywhere for investors who can stand the heat.

The major averages fell to three-year lows last week, following the terrorist attacks Sept. 11. Economists are now predicting that the U.S. economy, which was tilting toward recession, will suffer at least two quarters of contraction. And the profit outlook for companies is grimmer than ever. Nonetheless, value fund managers with at least a two-year investing horizon are more bullish than before, citing attractive prices.

"We've been buyers over the last few days," said managing director Bob Martorelli, who oversees two value funds for Merrill Lynch. "If you'd asked me two months ago, I'd have said it's difficult to find ideas with selective areas of attractiveness. But the precipitous declines over the last weeks have brought a variety of industries down to levels that are really attractive."

Bang for the Buck

Value strategies use various gauges to find ostensibly mispriced stocks. Adherents look for companies that are undervalued for short- to intermediate-term reasons, but have stable long-term growth prospects.

The most common way to value a stock is the price-to-earnings ratio. But with corporate profits under pressure and no telling when they'll bounce back, value fund managers say they're disregarding short-term earnings entirely. "We don't look at next quarter or [even] next year's earnings," said Martorelli.

"Nobody knows what growth is," agreed Mike Vogelzang, president and chief investment officer at Boston Advisors, who thinks value investing has gotten easier. "You have to sort of throw earnings out of the window because it's a horrible year for earnings. The only real way to approach the market is to understand where bottom valuations are."

Vogelzang uses a variety of value gauges, including price-to-sales ratios, price-to-book , price-to-cash flow, and a stock's dividend yield, depending on the company and the industry. He said he examines the price-to-sales ratio for software companies, for example, but on an insurance stock, he may look at its price-to-book value.

Value investors often cite historical evidence that shows their stocks tend to bottom during an economic recession and outperform growth stocks in the years following. Martorelli said his team has been "aggressively positioning" their portfolio by selecting stocks that have the "most earnings leverage off the bottom" and offer "the biggest bang for our dollar coming out of the slowdown."

Property and casualty stocks are looking cheap right now, said Martorelli, as well as paper and energy shares. He also likes media companies, including Viacom (VIA Quote) and Liberty Media , which has long traded at a discount to the market value of its component parts. Many of them are "generating a lot of free-cash flow in this environment," Martorelli said.

Growth Vs. Value

Some fund managers say the market selloff means that growth vs. value may no longer be a useful distinction. "I find that what may have been growth stocks have become more value-oriented," said Steve Jones, senior analyst at Value Line, noting that Red Hat (RHAT Quote), the Linux provider, and Nortel (NT Quote) have both fallen sharply from their highs, making them potential value plays.

"I think there are a lot of opportunities in the market and that most stocks are undervalued," said Barbara Marcin, portfolio manager at Gabelli Asset Management. "I don't think making a case for this versus that makes sense right now. You just need to find the good ones." Marcin, who runs a large-cap fund, likes American Home Products (AHP Quote), Cendent (CD Quote), Sprint (PCS Quote), Nextel (NXTL Quote) and Disney (DIS Quote).

Many growth-oriented names in the pharmaceutical and tech arenas are trading like value plays as a result of the "extremely volatile market," said Tim Quinlisk, senior vice president and team leader of value funds for John Hancock. Quinlisk "absolutely loves" Citigroup (C Quote) and also media giant Viacom. Texas Instruments (TXN Quote) also went on his list after it dipped below $21. "On a relative basis, there are more opportunities in the large-caps at this moment," Quinlisk said, "because of the fact that the blue-chip franchise has gone on sale. I think first and foremost people should be buying those."

Vogelzang prefers TranSwitch(TXCC Quote), a smaller chip company that's trading at $3.80, off from its 52-week high of $74.69. The company has about $5 in cash per share and no debt. "If they can minimize future losses and not burn cash, you're buying five dollars in cash for four dollars," said Vogelzang. "Who cares what earnings are? You're buying cash. And at some point in time earnings will turn around."