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Value stocks had a tough year in 2023. In the same year when the S&P 500 rallied 24%, the Dow Jones Industrial Average rose just 12.8% and the TSX merely budged 7.4%. These comparisons aren’t perfect, as the value-oriented TSX and Dow have higher dividend yields than the S&P 500. However, even if you add the small dividends into the equation, both the TSX and the Dow underperformed the S&P 500 last year.
It’s precisely for this reason that cheaper stocks have a good chance of outperforming in 2024. Generally speaking, stocks that are out of favour at time ‘T’ tend to be in favour at time ‘T + n.’ Exactly what number ‘n’ represents here is never certain; it does take longer than a year at times for undervalued stocks to rise to fair value. However, over a long enough period of time, stocks inevitably end up trading for what they’re worth.
So, it looks like cheap stocks are set to outperform at some point, and with today’s army of keen hedge fund analysts and other informed investors, the convergence to fair value could occur as soon as next year. In this article, I will explore why value stocks could surge in 2024.
Why value stocks could surge in 2024
The reason why value stocks could surge in 2024 is because the valuation gap between value stocks and tech stocks has grown since the end of 2022. At that time, value stocks were rising and tech stocks were in a full-blown bear market. In 2023, tech stocks rallied while value stocks only rose slightly. However, the earnings growth in several value sectors –particularly banking – was just as good as that seen in tech. So, tech stocks experienced multiple expansion compared to value stocks. Unless tech stocks outgrow value stocks, then this valuation gap should close. Should the next quarter’s earnings releases show tech stocks not outgrowing value stocks, then the gap will close sooner rather than later.
What to do
If you agree with me that tech stocks have gotten too expensive compared to ‘traditional industry’ stocks, then you should invest in some of the latter.
Consider The Royal Bank of Canada (TSX:RY). It’s a Canadian bank stock that trades at 11.8 times earnings, 3.5 times sales, 1.7 times book value, and 7.2 times operating cash flow. This is a pretty cheap valuation compared to the markets as a whole. These days, the S&P 500 trades at about 24 times earnings – it’s not cheap. RY stock, on the other hand, is trading at a pretty fair price.
Does it deserve a higher price? Arguably, yes. The company has a 150-year track record of financial stability, a large dividend, high profit margins, and modest growth. Odds are it will do reasonably well going forward.
As another example, consider Suncor Energy Inc (TSX:SU). It’s an energy stock that trades at 7.5 times earnings, 1.1 times sales, 1.3 times book value, and 4.6 times operating cash flow. Granted, the dirt cheap valuation here is arguably justified: the company’s earnings declined in 2023, even more than the stock price did. It’s pretty clear now that the sky-high oil prices of mid-2022 aren’t coming back, but you never know. We could see something like $80 as a long run equilibrium oil price. Prices made a run for $100 this year, and there isn’t much oil left in the world’s strategic petroleum reserves.
Value stocks: Foolish takeaway
Will value stocks rally in 2024? It cannot be said with any certainty, but the odds look favourable. Value stocks have underperformed compared to tech, while their earnings growth over the last two years have been satisfactory. I’d definitely be adding some value stocks and/or funds to my portfolio right now.
