Value Mutual Funds Pile Into Growth Stocks - TheStreet

Value Mutual Funds Pile Into Growth Stocks

Value funds are picking up growth stocks as their prices have sunk.
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NEW YORK (TheStreet) -- Templeton Growth Fund (TEPLX) - Get Report has focused on stocks selling at hefty discounts since it opened in 1954.

To find bargains, fund managers often bought unloved companies that faced significant problems. But these days, the portfolio includes blue chips with rock-solid balance sheets and attractive growth prospects. Big holdings include

Microsoft

(MSFT) - Get Report

and

Oracle

(ORCL) - Get Report

.

Has Templeton changed its stripes? Not at all, says fund manager Cindy Sweeting. Templeton can buy blue chips because their prices have sunk into value territory.

"Normally high-quality blue chips have traded at significant premiums to the market," Sweeting says. "But now companies with good earnings sell at discounts. That is nirvana for a value investor."

Templeton is not alone in shopping for quality merchandise. Other value funds that currently own traditional growth stocks include

Ariel Focus

(ARFFX) - Get Report

and

Homestead Value

(HOVLX) - Get Report

.

The blue chips began appearing on the radar screens of value managers in 2008 when stocks of all kinds cratered. As the rally began in 2009, investors raced to take on more risk, favoring shaky small stocks. Blue chips lagged the markets. In recent months quality stocks have closed some of the gap, but they remain cheap, argue the value managers.

The rally in risky stocks probably went too far, says Tim Fidler, a manager of Ariel Focus. "As the riskier stocks start to correct, you will do better in high-quality stocks," he says.

Sweeting of Templeton Growth uses estimates of future earnings and cash flows to figure what a stock will be worth in five years. She only buys when shares are at a 50% discount to the fair value.

Sweeting followed Microsoft for years, and it was always too expensive for her tastes. A decade ago, the stock commanded a price-to-earnings ratio of more than 60. After the tech bubble burst, Microsoft remained extremely profitable, but the P/E continued drifting downward for years. When the P/E hit the low double-digits in 2008, Sweeting began buying.

Today, the company is reporting rich profit margins and growing earnings, but the P/E is 13, a modest figure at time when the

S&P 500

has a multiple of 17. Sweeting says Microsoft has many opportunities to grow as the giant expands its search business. She says corporations will be buying more software as they replace outdated PCs and update to Windows 7.

Another blue chip that Sweeting began buying in 2008 is Oracle. The company has a solid balance sheet and strong cash flow.

Ariel Focus has long favored undervalued companies with clean balance sheets and stable cash flows. But the fund has rarely been able to afford the bluest of the blue chips. Now the biggest holding in the fund is

Johnson & Johnson

(JNJ) - Get Report

, one of the steadiest stocks in the market. While the company churned out growing earnings and dividends over the past decade, the P/E dropped from more than 20 down to the current figure of 12.

Ariel manager Tim Fidler also likes

International Business Machines

(IBM) - Get Report

, which has a P/E of 12. He says the company weathered the recession in fine form, consistently increasing earnings. Now earnings can grow in the high single digits as sales of software and services increase.

Peter Morris, manager of Homestead Value, looks for unloved stocks with sound balance sheets. He is a patient trader, waiting for stocks to come into his price range. After buying, Morris rarely sells. The fund has an annual turnover rate of 3%.

Morris took advantage of the downturn to grab

Cisco

(CSCO) - Get Report

, which commands a forward P/E of 12. "That is not a lot to pay for a company that has been a front runner in its industry for years," Morris says.

Another holding is

Hewlett-Packard

(HPQ) - Get Report

, which has a forward multiple of 9. He says the company can grow because of strong sales in Asia.

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Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.