The value factor isn’t dead, but it sure has taken its lumps for over a decade. An enhanced approach to value may worth considering for investors willing to wager on the factor’s resurgence. The First Trust Large Cap Value AlphaDEX Fund (NasdaqGM: FTA) offers an avenue to value enhancement.
FTA follows the NASDAQ AlphaDEX Large Cap Value Index, which is a departure from standard value benchmarks that typically focus just on price-to-book and price-to-earnings ratios.
The index features “growth factors including 3-, 6- and 12- month price appreciation, sales to price and one-year sales growth, and separately on value factors including book value to price, cash flow to price and return on assets,” according to First Trust. “All stocks are ranked on the sum of ranks for the growth factors and, separately, all stocks are ranked on the sum of ranks for the value factors. A stock must have data for all growth and/or value factors to receive a rank for that style.”
FTA helps investors take a more relevant, sophisticated approach to value.
“Despite sounding like a relatively straightforward investment strategy, Value is multifaceted, with considerable nuance,” said Mark Mandex, Nasdaq product development specialist, in a recent note. “The most basic implementation of Value investing seeks out companies with low price-to-book ratios, with the belief that these ‘cheap’ firms command a higher risk premium for a reason, and will ultimately deliver better-than-average returns in the future.”
Value stocks typically trade at cheaper prices relative to fundamental measures of value, such as earnings and the book value of assets. In contrast, growth stocks tend to run at higher valuations since investors expect rapid growth in those company measures.
What’s important with value investing is avoiding value traps, or those stocks that look like good deals but are really cheap for a reason; a reason that isn’t good.
“The Nasdaq AlphaDEX Large Cap Value Index (launched on January 11, 2016) attempts to tackle this problem by introducing a more refined approach,” notes Mandex. “Beginning with the constituents of the Nasdaq US 500 Large Cap Index, the index methodology ranks all 500 constituents on book yield (i.e., book value divided by price), cash flow yield (i.e., cash flow divided by price), and return on assets to determine a Value score.”
FTA, which soon turns 13 years old, allocates almost 38% of its combined weight to financial services and energy stocks – hallmarks of many value funds. However, the fund does have some growth avenues via a more than 19% weight to consumer discretionary and tech stocks.
For more on multi-factor strategies, visit our Multi-Factor Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.