In their emails to me, some readers are expressing concern about excessive valuations. Its true, the market is getting frothy. But you can still find reasonably valued growth stocks that are poised for outsized gains. Below, I pinpoint a safe, efficient way to play this trend.
Weve been enjoying a prolonged bull market, with stocks hovering at record highs. The key now is to focus on strong financial metrics that include low debt, robust free cash flow, and positive projected earnings growth. Its also important that these companies provide products and services that customers will need well into the future.
In the stock market, todays laggards can be tomorrows winners. Were currently in the midst of a market rotation, whereby value stocks are outpacing growth stocks. Market rotation is when money stays in the stock market but moves from one style, sector, asset class, or other attribute to another.
Certain sectors of the economy typically outperform or underperform the broader market, depending on the stage of the economic cycle. Right now, you should bet on economically sensitive stocks that will prosper during the economys reopening.
High growth stocks have made dramatic runs, particularly over the last year. But with inflation expectations on the rise, investor appetite for value stocks, which historically outperform during inflationary periods, is growing.
You should consider T. Rowe Price Small-Cap Value (PRSVX), an actively traded mutual fund that invests at least 80% of its net assets in companies with a market capitalization that is within or below the range of companies in the Russell 2000 Index. The overvaluation of large-cap stocks highlights the wisdom of seeking small-caps, which are poised to outperform in 2021.
With a net asset value of $13.2 billion, T. Rowe Price Small-Cap Values holdings skew toward the market valuations of the Russell 2000, the most common benchmark for mutual funds that identify themselves as small-cap.
The weighted average market capitalization for a company in the Russell 2000 index is about $2.4 billion; the median market cap is $861 million. The index has gained 15% over the first four months of this year, as pandemic-induced lockdowns ease and economic growth accelerates.
PRSVXs portfolio is well diversified. Holdings are spread among several sectors. The top five sectors are financial services (27.2%), industrials (16.9%), consumer cyclical (10.4%), real estate (9.9%), and health care (6.9%).
The funds strategy has paid off (see table).
Lead manager J. David Wagner looks for small companies that are trading at a bargain relative to their industry peers. The median market capitalization within the fund is $1.5 billion.
You should be wary of investing in momentum stocks that are overvalued based on unrealistic earnings assumptions. Small-cap companies can bring sanity to your portfolio, especially the value-oriented picks in PRSVX.
As a value strategist, Wagner pinpoints companies with strong potential earnings growth that isnt reflected in their share prices, a calculation thats a smart stance amid todays market rotation.
Top PRSVX holdings such as Western Alliance Bancorp (NYSE: WAL) and Home BancShares (NSDQ: HOMB) are prudently managed, regional lenders with dominance in fast-growing markets. Another major PRSVX holding in the sweet spot for growth is Belden (NYSE: BDC), a maker of industrial switching equipment.
With a reasonable expense ratio of 0.83%, T. Rowe Price Small-Cap Value represents an investment trifecta: small-cap growth, reasonable value, and a market rotation play.
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