Over the long course of history (since 1927), value stocks have outperformed growth, but not so in the last 15 years. That recent slump might put even more ‘value’ inside value stocks.

There are plenty of investors who believe in value stocks. One is Sam Peters, a co-manager of ClearBridge Value mutual fund  (LGVAX) – Get Free Report. ClearBridge is a subsidiary of mutual fund titan Franklin Templeton.

With the market’s focus centered squarely on the Magnificent Seven growth stocks – Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla – plenty of bargains are available among value stocks, Peters says in an interview with TheStreet.

Exploiting market overreaction, underreaction

He says investors tend to overreact or underreact to a lot of investment news, putting some stock prices out of whack compared to their valuations. And he tries to seize on those opportunities to pick up stocks with strong fundamentals at bargain prices.

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Peters likes companies with strong free-cash-flow yields and fortress-like balance sheets. Given the transition to clean energy and strong power demand, he sees energy stocks as attractive now.

ClearBridge Value has generated an annualized total return of 14.2% over the past year, 9.8% over the past three years, 12.8% over the last five years, and 9.34% over the last ten years, according to Morningstar.

That beats the Morningstar large- and mid-cap value stock index for one, three, and five years but trails it for ten years.

Given his solid performance track record, paying attention to what Peters says regarding stocks could be profit-friendly.

Peters’ philosophy, value stock picks

We recently chatted with Peters about his investment views, including stock picks. Here’s what he had to say.

Street.com: What’s your investment philosophy?

Peters: Most of the time, the market is efficient: the price and valuation of a stock are within 30% of each other. When price and valuation get separated by more than 30%, there’s overreaction or underreaction.

Human nature is fixed. People hate downside volatility, so every year, there is some opportunity. In October, yields rose dramatically. Defensive stocks, like utilities such as NextEra Energy  (NEE) – Get Free Report, fell as much as 40% in a week. [Utility stocks tend to fall when interest rates rise.]

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In terms of underreaction, people hate change. When there’s a new regime, people look back. For example, people are anchored to the 15 years of free capital [that ended in 2022, when the Fed began raising interest rates]. People are acting as if that’s still there. We want to benefit from surprises.

Street.com: What’s the attraction of value stocks?

Peters: Now everyone owns the same stocks. When you get record concentration in a few stocks, you get great valuations on other stocks that have great fundamentals. Those are companies with high cash-flow yield and fortress-like balance sheets.

So, their investment return is well above their cost of capital. You’re getting a free option on growth for these stocks. Value stocks are also a critical diversifier.

Street.com: As a bottom-up stock picker, do you particularly like any sectors?

Peters: Artificial intelligence is huge, which leads to the energy transition and power sector. For AI data centers, the ability to get power is so important. We will have to spend a tremendous amount on the grid [for AI and everything else]. The government is already doing so in the Inflation Reduction and CHIPS Acts.

Energy and commodity stocks are very out of favor. But they have resilient cash-flow yields. About 30% of our portfolio is in power stocks.

Street.com: Are there any sectors you dislike?

Peters: People are trading as if the era of free money isn’t over. A lot of companies are junk. They don’t have free cash flow and good balance sheets. We avoid growth junk. There are a lot of wonderful growth companies. But some are speculative junk, and some people love these.

Street.com: Are there any market themes that particularly interest you?

Peters: One theme that isn’t priced into the market is that inflation could cycle back up, ranging from 2%-5% over the next five to 10 years. While I see only a 20% chance of that, it’s still significant.

If the economy is resilient, the idea that we will get and stay at 2% inflation may be wrong. Also, inflationary is Congress’ zero discipline to be fiscally prudent. That’s why we like commodity and energy stocks.

Street.com: Can you discuss three of your favorite stocks?

Peters: 1. Noble  (NE) – Get Free Report is an offshore oil and gas driller. It has a huge upcycle in its offshore drilling – off the coast of Brazil and Guyana. It has a fortress balance sheet and will grow free cash flow yield in double digits. If you can buy stocks with double-digit growth in free cash flow yield, you will get double-digit returns.

2. Corbridge Financial (CRBG) is a retirement insurance company. It has a double-digit free cash flow yield, a 3.8% dividend yield, and will buy back stock. It benefits from the normalization of the cost of capital. Retirees go for yield products, where Corbridge specializes.

3. Vistra  (VST) – Get Free Report is a utility focused on Texas. It has a 10% to 15% free cash flow yield on its enterprise value. It’s a beneficiary of higher power prices. There’s huge demand in Texas; power prices took off there. There’s not enough power to go around. So there’s a lot of investment in the grid.

The author owns shares of NextEra.

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