Bargain Hunters Still Ferret Out Some Buys

Perhaps the most amazing thing about this year’s stock market rally is that value investors are still participating in it.

You would expect bargain hunters to throw up their hands and flee to the sidelines with a 23% year-to-date advance for the Dow Jones industrial average. Yet many investors who follow a value strategy, including numerous mutual fund managers, continue to find cheap stocks to put into their portfolios.

Stock mutual funds have only 7.5% of their assets in cash, down from 8.6% a year ago, according to the Investment Company Institute in Washington, D.C. This indicates portfolio managers still are buying stocks--or at least not selling.

“We’re finding so many interesting ideas that we’re staying amazingly busy,� says Rob Friedman, a vice president at the Mutual Series fund group in New Jersey.

The company last month reopened its Mutual Discovery Fund, a respected cheapskate portfolio, to new investors for the first time in two years.

Value investors look for companies that they see as cheap, based on fundamental measures such as low price/earnings ratio, low price/book value reading or high dividend yields.

Dividend payouts have dropped to alarmingly low levels of about 2.5% for the companies in the Standard & Poor’s 500, yet many of the other measures are holding their own. Thanks to strong corporate profits, the S&P; 500’s price/earnings level, for instance, currently stands around 17--a reasonable number.

Besides, various sectors of the market simply haven’t participated in the current rally, creating pockets of value. Some examples:

* Real estate. Lower interest rates haven’t yet translated into a sustained rally for real estate stocks, despite a nice move over the past week or so. Mutual funds that target companies in this industry gained just 1.9% over the 12 months through June 30, reports Lipper Analytical Services of Summit, N.J.

After a string of strong years in the early 1990s, “money has been moving out of the industry over the last 18 months,� says Mike Oliver, portfolio manager of the Heitman/PRA Real Estate Securities Fund in Chicago.

Yet most sectors of the real estate industry remain healthy, Oliver adds, being characterized by rising rents and occupancy levels and modest new construction activity.

As a sign of value, real estate investment trusts, or REITs, are currently paying dividends of about 8% on average, Oliver says. REITs, unique companies offering modest tax-sheltering benefits, have emerged as the main way to invest in real estate within the stock market.

* Financial services. This is a surprising value pick because companies in the brokerage, insurance, banking and money-management businesses already have participated in the current rally, notably so in some cases. Yet the recent easing of interest rates still makes many of these firms good buys, some managers say.

The Clipper Fund, a value-oriented portfolio in Beverly Hills, has loaded up on financial stocks to the point that they now represent 50% of assets. Two mortgage-related firms, the Federal National Mortgage Assn. (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac), are among the largest holdings.

“Some financial companies, despite the rally, are still undervalued,� says Michael Sandler, Clipper’s portfolio manager.

Mutual Discovery Fund also counts several financial stocks among its holdings, says Friedman, including insurers Allstate, Torchmark Corp. and CNA Financial.

* Foreign stocks. While pockets of bargains still exist in the domestic stock market, many of the best values appear to lie overseas.

Mutual Discovery currently holds about 35% of its assets in foreign shares, and that allocation could grow to perhaps 50% or more relatively soon, Friedman says. The fund’s portfolio managers are finding some of the best values in Europe.

Conversely, Rick Mace, who has a hand in running three foreign funds for Boston-based Fidelity Investments, believes Japan offers some of the best global bargains. Mace has staked 39% of the assets of Fidelity International Growth & Income on Japanese stocks, and he has a 50% Japanese weighting in Fidelity International Value.

Japanese stocks have been in a tailspin for most of the 1990s. They’ve rallied in recent weeks but remain sharply lower for the year to date.

Mace describes Japan not as a basket case but as an “emerging market.� He believes the prospects for financial deregulation will boost shareholder value in Japan, and he predicts the profitability of Japanese manufacturers will improve as more companies set up factories in lower-cost developing nations.

In addition, Mace says, a strong rally in Japanese bonds earlier this year has left stocks cheap by comparison. Even with a recent modest rally, the Nikkei 225-share average remains around the 16,000 level, down from 39,000 in late 1989.

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Value Pockets

What kinds of stocks aren’t participating strongly in the recent market rally? Compared to the 16.63% average gain for the typical well-diversified U.S. stock fund, here are some laggard categories during the first half of 1995:

Fund Category YTD Return (1st Half 1995) Natural Resources* +9.79% Real Estate** +3.12% International +2.30% Gold +1.76% Japan --13.74% Latin America --20.55%

Source: Lipper Analytical Services * oil, mining, forestry

* * including trusts