It’s an excellent question, and my answer speaks to my particular eclectic brand of stock picking. Both cheap value stocks and more glamorous growth stocks can work well in a portfolio—if done right.
Many investors struggle with this because they feel compelled to pigeonhole themselves into one style. They often pick a strategy simply because it feels right in their gut. Value often smells better to a different breed of investor than growth does. But having different types of stocks in your portfolio can enhance returns.
Fundamentally cheap stocks are often held in low regard by market participants. Something may be tainting their perception in investors’ minds. If a stock’s results begin to demonstrate that its woes are overstated, its price/earnings multiple will expand. If a stock’s multiple goes from, say, eight to ten, and its EPS rises by 12%, it can move a stock 40%.
Generally variations in earnings aren’t nearly as impactful on glamour growth stocks as are changes in image and, well, sexiness. I often think of glamour stocks as though they are attractive women dressing to the nines. You need to figure out whether your hot prospect is real or just a tease, because it’s a lot harder to expand a P/E of 30 even with a 25% EPS boost. When a growth stock’s sex appeal is real and its earnings jump, a multiple boost can produce big price gains.
Cisco Systems CSCO -1.06% (NASDAQ:CSCO) is an overblown, 1990s-highflier, takeover-crazy tech wreck that is now a big, cheap value stock—growing moderately with technology solutions spanning virtually everything we do in communications. Without it we don’t grow. With a $116 billion ?market cap, 72,000 employees and $46 billion in revenue it sells at a mere 11 times my July 2013 earnings—with a 2% dividend yield.
Continue reading Fisher's column at Forbes here.