Deep value looks attractive, and Guggenheim’s S&P 500 Pure Value (RPV | A-61) is a top pick in the space.
The positive outlook toward deep value can be broken down into two recommendations. First, value stocks are poised to end the long period of growth outperforming value. Second, within value, deep value stocks rank as the most attractive.
Index Design
Pure value, as suggested by its name, creates a more intense exposure to value stocks. In contrast to the S&P 500 Value, pure value includes just one-third of the market capitalization. The S&P 500 Value includes half the capitalization and includes some stocks that are also included in the S&P 500 Growth. Pure indexes eliminate the positions that are a mixture of growth and value characteristics.
Once the universe is pared down, the portfolio is weighted based on the value characteristics of the stocks, rather than the market capitalization. For example, HP Inc.—the computer and printer portion of the old Hewlett Packard—is only 0.24% of the S&P 500 Value. It is the second-largest holding in RPV, at 2.41%.
Performance
In the era of the smart-beta ETF, the talk about which factors add value over the long run includes a relatively narrow list. Value is almost always on the list. Yet over the last 10 years, value has lagged growth considerably. While pure value has done better than traditional value, it too is behind. Over the last two years, RPV has lagged significantly. Given the gap, value bouncing back is likely.
Valuation
One reason to expect a bounce back is that pure value is cheaper than normal. Because the index includes stocks with low valuations, that is normally the case. Yet the current gap between pure value and other indexes is wider than normal. The table below shows how attractive RPV has become relative to other indexes.
Source: Morningstar Direct; includes only periods with a positive P/E ratio
The average 10-year price-to-earnings ratio shows that value stocks are generally cheaper than growth stocks. I included the iShares Morningstar Large-Cap Value (JKF | A-91), because it has similar holdings to RPV, but weights its holdings based on capitalization. The current P/E shows the values at the end of March. While most of the ETFs have seen an increase in valuations, RPV is slightly cheaper on an absolute basis.
The next two columns calculate the difference between the P/E ratio for RPV and the other ETFs. The first column shows RPV is normally in line with Morningstar Large Value, somewhat cheaper than S&P 500 Value, and much cheaper than S&P 500 Growth. The final column shows current values. The gaps are all much larger than normal and reflect that RPV is significantly cheaper than usual. I expect the gap to narrow.
