Over the last two weeks, much of the investment world has been focused on the earnings of high-growth stocks like Facebook and Amazon, both of which saw their stock price rise 8 percent and 11 percent, respectively, after posting big numbers last week. Investors love these companies — they're fun to watch, they bring in big revenues, and if they exceed analyst expectations, their stock prices can soar, too.
However, if you really want to make money in the market, then you should consider owning value companies instead. Numerous studies show that over time, value outperforms growth. So far this year, the S&P 500 Pure Value index is up 7.3 percent, compared to 2.5 percent for the S&P 500 and minus 0.5 percent for the S&P 500 Pure Growth index.
If anyone knows how to make money finding value stocks, it's Charles Brandes, a legendary investor who studied directly with Benjamin Graham, the father of value investing. According to Forbes, the founder and chairman of Brandes Investment Partners has a net worth of $1.18 billion, and he made much of his wealth managing funds that invest in cheap, beaten-down stocks that no one wants but him.
While his process has its ups and downs, over time it's worked well. His Brandes Emerging Markets Value fund has returned 18.6 percent year-to-date and around 7 percent annualized since inception in 1996. The Brandes Global Opportunities Value Fund, which allows his team to find buys anywhere around the world, is up nearly 10 percent year-to-date.
What's the key to making money in value stocks? We asked the investor for his advice.
1. Search for value.
Brandes has a four-step test that the average investor can apply to any company that catches their eye. A good company should have sustained no losses over the past five years, its total debt should be less than 10 percent of total tangible equity, its share price should be less than the book value per share, and its yield, if it has one, should be at least twice the yield on long-term AAA bonds.
2. Stay the course.
As well as value investing has done this year, there can be long stretches where value stocks underperform. According to CNBC, in late 2015 value stocks were underperforming the broad market by its widest margin since 2000.
For investors, these periods can get dark — value stocks tend to be ignored by the general public and then only rebound when people start paying attention again. After all these years, Brandes still gets calls and emails from clients wondering why he's sticking with a position when others have cashed out.
"Value investing has a lot to do with being antihuman," he said. "People act on emotions, and that will never change. You have to think very differently and independently and counter to everyone else."
This was especially true during the tech boom, he said. Everyone was jumping on the internet bandwagon, while he didn't own any tech stocks at all. Other value managers went out of business because they couldn't make any money in what they owned.
When the bubble burst, his global equity fund outperformed its benchmark by 36 percent. According to Institutional Investor, between 2003 and mid-2006, when value soared, his firms' assets under management climbed from $76 billion to $117 billion. (Its AUM has since fallen to about $27 billion.)
He said that while his clients might feel the need to sell, he's trained himself not to feel that pull. Instead, he feels pressure to buy more in a bad market.
"Down markets are an opportunity," he said. And now is the time to go on the prowl. Another value-related rebound started in February, he said, in part because people are finally looking for new ideas and finding them in value stocks.
"It's a normal cyclical change that always comes," he explained. "All the people who are going passive and going high-quality have already done that — that's over again. So now they're going somewhere else."
3. Consider emerging markets.
Emerging markets account for 42 percent of global GDP, 23 percent of the global investable equity universe and 10 percent of the MSCI All-Country World Index. That is why investors cannot overlook the sector's vast potential.
The average investor has around 5 percent allocated to the area. "It should be higher given the value of opportunities that exist in the asset class," he explained. But many investors are nervous about economic certainty. And for good reason. Emerging market investments have been stuck in a long bear market, and for many professionals the asset class has become "the big short."
Despite big risks, it may be time to look for opportunities. Brandes has always found big returns in developing nations. He was one of the first investors to buy stocks outside of America. One of his first was Teléfonos de México, now Telemex, which he bought in 1983, reaping huge profits on the stock over the last 40 years.
Brandes actually sold off many of his emerging market investments around 2009, well before people started rushing out of these nations, as they were getting expensive, he said. But now he's buying. In 2011 he had less than 2 percent of assets in emerging markets in his Brandes Global Equity Fund. That's increased to nearly 20 percent today.
One country that's looking particularly attractive is Brazil. Headlines of impeachments and economic woes have made many stocks cheap. Yet there are still good global operations. For instance, he likes Embraer, a Brazilian aerospace company that competes with the struggling Bombardier and is doing well internationally.
He also likes Brazilian banks and food companies. His firm currently holds Banco Bradesco, a well-capitalized bank and leading player in the Brazilian insurance industry, and Cia Brasileira de Distribuicao, a onetime pastry shop that's grown into the largest food retailer in Brazil.
While he admits that the news out of the country isn't great — its GDP is shrinking by around 3.8 percent, its president is facing impeachment — he's over-allocating assets to the nation. "[Our stocks] have done extremely well this year," he said. "The market got too low, but it's coming back."
4. Buy the seemingly bad stocks.
Many stocks get so badly beaten down that no one in their right mind would want to touch them. But these are types of companies that investors should buy, he said. Many are in sectors that tend to do well over the long term — he's made a lot on utilities and manufacturing companies — though some are just too good of a deal to pass up.
For instance, he's currently buying into Russian oil and gas stocks, which might seem crazy to the average investor, but it makes a lot of sense to him as a contrarian play. The Russian index is currently trading at about 5 times earnings, he said, which is incredibly cheap. He stared buying right after the Ukraine crisis, when everyone else ran from the country. What he saw, though, were companies with valuations cheaper than anything else in the world. Many of his positions have doubled since, while Lukoil is up 19 percent year-to-date.
What to look for in a stock depends on the sector, but generally, a lot of value investors do look at price-to-earnings and price-to-book ratios. For instance, when it comes to a financial operation, he looks at tangible book value — he'd want to buy a bank at a big discount to this metric — how much capital it has, its loan portfolio and whether those loans could withstand defaults during a recession.
With tech companies, he's looking much more at cash flow, free cash flow and balance sheets. He wants to know that it can afford to innovate. "Take Microsoft. Everyone's moving to the cloud, how is it going to do that?" he asked.
— By Bryan Borzykowski, special to CNBC.com