Note from Ashley Cassell, Managing Editor, TradeSmith Daily: When market volatility ramps up like this, our analysts are particularly careful to avoid the mentality that leads investors to "catch a falling knife" – and end up getting sliced.
But that really only applies to struggling, out-of-favor companies. Some of the most legendary investments of all time were value plays…on extremely high-quality companies with staying power.
So, today we brought in Mike Burnick, who loves a good bargain, to share the right way to hunt for value stocks. The method he describes below can help you understand if a stock is down for the count… or truly has what it takes to climb back up and win for you over the long term. |
Here's How to Spot Wall Street's Blue-Light Specials By MIKE BURNICK, SENIOR ANALYST, TradeSmith When I was a kid, my mom and dad would drag me along on their weekly errands. This usually included a stop at our hometown Kmart, followed by the nearby grocery store. It was always exciting to me, in an otherwise boring trip, when the store suddenly flashed a blue-light special. The aisle would be brightly illuminated by the flashing light, like a police car that just pulled over a speeding car. Shoppers couldn’t help but flock to that aisle in search of bargain-priced merchandise they could scoop up on sale. Investing in value stocks is kind of like finding the blue-light specials on Wall Street. Lots of stock pickers dream of bagging a hot growth stock – the next Nvidia (NVDA), you might say. But just as many, if not more, simply can’t resist the bargain-priced appeal of value stocks. Here’s an easy method to find outstanding value stocks ”the TradeSmith way.” Defining the Debate Investors can be every bit as committed to their preference for growth versus value as they are about Coke versus Pepsi, Mac versus PC, and Star Wars versus Star Trek. First, let’s start by understanding that the debate between growth versus value isn’t about absolutes. There are plenty of shades of grey to consider. What exactly is a value stock? There are many ways to define value, but I prefer the definition as found in our exclusive Value Strategy tool available to Trade360 subscribers, for instance. To create it, our quants crunched the numbers and found that certain fundamental factors work well at identifying value stocks. Namely, a low price compared to: - Book Value per share
- Earnings per share
- Sales per share
And while growth and value stocks take turns outperforming each other over time, with their leadership carrying on for years at a time, value does hold a slight historical edge. Let’s start with the big picture. As you can see below, stocks with lower relative prices (value) have outperformed growth stocks historically by an average of about 4.4%. Of course, that average masks some pretty wild year-to-year swings. Outperformance for value versus growth or vice versa tends to come in bunches: 
Often, growth or value will outperform the other over several years straight. Most recently, growth stocks outperformed from roughly 2015 to 2020. But since the pandemic, value stocks have had the upper hand, at least until 2023. One of the easiest ways to track value versus growth for yourself is by keeping an eye on two popular low-cost ETFs: Vanguard Value ETF (VTV) and Vanguard Growth ETF (VUG). The TradeSmith chart below directly compares VTV to VUG performance over the past three years. VTV (green line) outperformed VUG (blue line) by a wide margin in 2022 and the early part of 2023: 
Since then, however, growth (VUG) has closed the gap considerably. But overall, value (VTV) still has the upper hand over the past several years. Know This Before Loading Up on Value Stocks Just like you don’t want to pay too much for overpriced growth stocks, there’s also a warning that comes with value-stock investing. Namely, you don’t want to buy value traps. These are stocks that just can’t seem to get their act together, with the stock price going nowhere for years. Value-trap stocks can become a black hole for your hard-earned money. So, while it’s all well and good to invest long-term in your stock portfolio, you don’t want your cash tied up all that time waiting for a turnaround that never comes. One great example is Intel (INTC), which was one of the hottest tech stocks around…24 years ago. After reaching lofty highs in the dot-com days, though, INTC was in the wilderness for 18 years before even approaching that level again. Similarly, today it just can’t seem to hold onto its levels from the 2020-2021 bull market…and investors who “bought the dip” in August have been disappointed yet again. 
So, when looking for value stocks to invest in, be sure to also insist on quality value stocks: those stocks that are turning in consistent returns, positive cash flow, and balance-sheet strength. Above all, the best way to avoid value traps is to look for healthy stocks in a confirmed uptrend according to our TradeSmith indicators – or at the very least a sideways trend. The strategy I’m about to show you is easy to deploy by setting up a custom screener with our TradeSmith Value Strategy as the centerpiece, plus filters to help weed out potential value traps and uncover quality value stocks that are performing well. Our Screener tool is available in Trade360 as well as Ideas by TradeSmith, TradeSmith Essentials, and TradeSmith Platinum. So, with any of those subscriptions, you’ll be able to set up a screener that fits the criteria I’m about to describe. First, you’ll want to start with healthy stocks, which in TradeSmith terms include: - Green Zone stocks, which are trading normally based on historic performance and are “good to go,” or
- Yellow Zone stocks, which means caution but can be a great buy-the-dip opportunity.
(You’d avoid Red Zone stocks for initial screening purposes because they are unhealthy.) As for the price trend, you should focus on stocks in a confirmed uptrend or at the least in a sideways trend, which our price-trend analysis algorithms can help you determine. Avoid downtrending stocks. Next I’d use one of our TradeSmith Strategies, “Value,” to screen for stocks with the value characteristics I listed above. To help avoid value traps (or stocks that are going nowhere fast), you’d add a Performance filter. We know the S&P 500 was up about 2% last month, so let’s screen for stocks that are outperforming with a One-Month Change of “more than 2.5%.” Finally, you know by now that I’m a big fan of quality. And focusing on stocks that TradeSmith assigns a high Business Quality Score (BQS) will also help you avoid value traps. By setting a BQS filter to more than 50, you could narrow the field to the top half of stocks in our database by quality. In TradeSmith, my screener filters will look like this: 
And here are the top 10 results that screener gave me on Friday, sorted by ”Business Quality Score, DESC” (descending) to get the cream of the crop at the top. 
Several financial stocks made the cut along with some classic blue-chips. Most of them have solid dividend yields well above the broad S&P 500 average of 1.3%; that’s a play that makes sense as the Federal Reserve prepares to slash interest rates. Growth companies stand to benefit from lower rates (on their debt) as well, but why not continue to enjoy a solid yield yourself with the high-quality dividend payers among these value stocks? Mike Burnick’s Bottom Line: Think of value stocks as the other side of the coin from growth. Each strategy takes turns outperforming the other. Over the past few years, the blue-light special has been flashing on Wall Street’s value-priced merchandise. And our TradeSmith screening tools are a great way to uncover quality value stocks that are rising to the top in performance. Good investing,  Mike Burnick
Senior Analyst, TradeSmith | 
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