Value Sector’s Vital Signs: Due for Improvement?

As growth industries go, death was a pretty good one for much of the 1990s.

But it now appears that, despite that old line about only death and taxes being certainties, we’re left with taxes alone.

Last week, Service Corp. International, the nation’s largest funeral home and cemetery owner, stunned Wall Street by warning that its fourth-quarter earnings would be well below analysts’ expectations.

The problem is simple enough, the company said: Too few people are dying in its main markets.

Maybe that’s not so surprising. Who has time to die when there’s so much Internet to surf--and so many Internet stocks to trade?

In any case, Service Corp.’s stock, which began the week at $34.63 on the New York Stock Exchange, ended the week more than half off, at $15.88 on Friday.

And what was bad for Service Corp. was bad for the entire “death-care� industry, as it prefers to be known.

The Pauze Tombstone index (the ticker symbol for which is RIP), which tracks eight companies that derive a significant portion of their sales from providing goods or services to the death-care business, plummeted 39% for the week, closing at its lowest level since early 1995.

Now, it used to be that stock declines of that magnitude, in such a short period, would at least prick up the ears of “value� investors--people who made a living investing in out-of-favor stocks, betting that other investors were overreacting to bad news and failing to appreciate the companies’ long-term prospects.

But it’s becoming a running joke in the investment business that the last followers of the value investing discipline may have been among Service Corp.’s relatively few “clients� in 1998.

Consider a few numbers from mutual fund tracker Morningstar:

* The average mutual fund that invests in large-capitalization growth stocks--issues like Microsoft and MCI WorldCom, for example--scored a 35.8% return last year, as an avalanche of fresh cash poured into those stocks.

* The average fund that invests in large-capitalization value stocks, by contrast, mustered a gain of just 12.3% in 1998, as relative value stocks such as Philip Morris and Texaco generated little enthusiasm at best, and outright contempt at worst.

* The disparity between growth and value continued down the stock food chain. Smaller stocks in general were in far less demand than bigger stocks last year, but the average small-cap growth fund still eked out a 4.8% gain. The average small-cap value fund, meanwhile, lost 6.7% for the year.

Nor has value’s situation improved much this year. Barra Inc. indexes that split the shares in the blue-chip Standard & Poor’s 500 index into either the growth camp or the value camp show the growth segment up 6.1% this year, versus a 1.9% gain for the value segment.

The simple explanation for growth stocks’ extraordinary market domination over the last year is that investors, perhaps more than ever, are in a mood to stay with big winners--and ignore most of the rest of the market.

There’s a certain self-fulfilling aspect to that game, of course: The more a stock goes up, the more it becomes identified as a winner that other growth investors then feel they ought to own, and fast. (“Momentum investing� is the rather unkind term for this style.)

Still, what growth-stock investors seek, above all, are companies with rapidly rising earnings. And on that count, most of their favorite names have been delivering.

Microsoft shares, for example, may have looked expensive a year ago, but the company continues to report quarterly earnings gains far above analysts’ estimates. And so a $75 stock price a year ago, then 49 times the firm’s most recent 12 months’ earnings per share, has now become a $175 stock price that is 74 times earnings.

“Hey, knock yourselves out,� the traditional value players would say to growth investors who are willing to pay those kinds of prices.

The value discipline requires that investors shop for stocks with relatively low price-to-earnings ratios and low valuations by other measures, such as price-to-book-value (the per-share worth of a company’s assets). The basic idea is to buy assets cheap and sell them when other people finally catch on.

Now, given that the majority of stocks on both the New York Stock Exchange and the Nasdaq Stock Market declined in price last year--despite the gains in major stock indexes like the S&P; 500--one might presume that value investors have no shortage of stocks from which to pick.

But after eight years of a mostly rising market, many value veterans say the problem is that true value is nearly impossible to find, even after 1998’s pullback in most stocks. “I don’t see much cheap in any area� of the market, says William Mason, an old value hand at Cullen Fortier Asset Management in Woodland Hills.

So it isn’t that value investors have vanished, Mason and others argue, so much as they’ve become increasingly uninterested in putting new money to work.

Those value fund managers who have no choice but to stay fully invested in stocks, meanwhile, have been forced by rising stock valuations to settle for “comparative� value--stocks that are more expensive than the managers would like but far cheaper than the Microsofts of the world.

For investors who can take a longer-term view of the market, it’s worth asking: Which investment discipline--growth or value--is more likely to win over time?

Looking back 15 years (through 1998), Morningstar data show that the performance differences between the two strategies narrow dramatically: an average annual return of 15.1% for large-cap growth funds and 14.6% for large-cap value; 10.4% for small-cap growth and 11.4% for small-cap value.

If that’s the long-term story, it suggests that growth stocks’ dominance over the last year won’t last forever and that, more likely, value stocks are due to catch up.

The question is timing: Does value catch up over the next year, or does it take five years--or even 10? True value investors tend to be patient. They often have to be.

Meanwhile, how about the death business? The annual U.S. death rate has actually held steady in recent years at about 8.8 per 1,000 population.

Science, of course, is trying to lower that number. Which means death may not be a true American growth business near-term--but it’s still one of the few businesses that can count everyone as a customer eventually.

Tom Petruno can be reached by e-mail at [email protected].

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Morbid Returns

The Pauze Tombstone stock index, which tracks eight companies whose businesses are closely tied to the “death-care� industry, has plunged since mid-1998. Most recently the index has been dragged down by weaker-than-expected sales at funeral home and cemetery giant Service Corp. International. Other stocks in the index include granite-memorial maker Rock of Ages and casket maker Hillenbrand Industries. Quarterly closes and latest for the index:

Friday: 299.50

Source: Bloomberg News