It’s been a great five years to say the least for the stock market. Since bottoming out during the Great Recession, the SPDR S&P 500 (NYSE:SPY) has more than doubled as investors have plowed back into stocks. Adding to these gains has been the accommodative policies by the Federal Reserve and other central banks.

Yet, with such huge gains now on the books, many analysts and investors are starting to get uneasy about stock valuations.

Various metrics- like price-to-earnings (P/E) and price-to-book (P/B) ratios- are now at the top range of their historic norms. That’s prompted many investors to abandon the broad market and raise cash. However, investors may not need to flee stocks altogether. The key is to tilt your portfolio towards finding value.

Finding What’s Cheap

There are many styles of investing, but the two biggest are growth and value investing. Growth investors tend to focus on firms that are expected to deliver faster-than-average growth in revenue, earnings or cash flow. Generally, these investors are looking for large capital gains and significant share price improvements over a relatively short period of time. Since the crash back in 2008, growth stocks like Menlo Park, Calif.'s Facebook (Nasdaq:FB) and Seattle-based Amazon (Nasdaq:AMZN) have been the go-to investment for many portfolios and have surged to new highs.

However, the problem is as these firms' share prices have surged, so have their valuations.

Currently, the S&P 500 is trading for a P/E of 18- well above its historic norm. According to New York investment manager BlackRock (NYSE:BLK), valuations for certain sectors- like biotech and social media companies- are further stretched and could be sells as risks don’t match up with potential rewards.

Given this commentary and scenario, it’s easy to see why investors have begun to sell off growth names in spades. The tech orientated Nasdaq is down about 0.4% so far in April. The key for portfolios lies in that other style of investing called value.

Value investors seek stocks of companies that they believe the market has undervalued. They do this by screening for stocks with lower-than-average P/B or P/E ratios and/or have high dividend yields. For investors looking for new investments in the current market or shifting some long term gains, this style could be exactly what they are looking for.

Betting On Value

With the wheels falling off the growth train, the time to shift into the value-side of the market could be at hand. Luckily for investors, adding a dose of value is quite easy. A great starting point is the dirt cheap Vanguard Value ETF (NYSE:VTV).

The ETF tracks the CRSP US Large Cap Value Index (Nasdaq:CRSPLCVT) and currently can be had for a P/E ratio of just 15. Among its 313 holdings include firms like Irving, Texas-based energy giant Exxon Mobile (NYSE:XOM) and New York pharmaceutical firm Pfizer (NYSE:PFE). Aside from its cheap P/E ratio, expenses for VTV are ultra-cheap as well- costing only 0.10%. For those investors looking for a name-brand index, the iShares S&P 500 Value (ARCA:IVE) can be used to track value stocks within the benchmark.

While both the VTV and IVE can provide broad exposure to value-titled stocks, they aren’t perfect. One of the main criticisms is that there is some overlap with their respective growth index counterparts. To that end, the Guggenheim S&P 500 Pure Value (NYSE:RPV) may be a better choice. RPV uses screens to remove the overlap between growth and value stocks in the S&P 500. That produces a smaller and more concentrated portfolio of stocks. Currently RPV has just 118 firms. It also adds plenty of extra returns. The ETF managed to return nearly 48% in 2013. That’s versus just 32% for the traditional S&P 500 Value index.

Another way to bet on value is through dividends. According to Chicago-based Morningstar (Nasdaq:MORN), high-yielding dividend stocks tend to be less volatile than other value stocks over a full business cycle. Yet they still offer many of the long term extra gains in return. Given this fact, the SPDR S&P Dividend ETF (NYSE:SDY) could be a good choice. The ETF tracks 97 different dividend paying stocks. The kicker is that SDY’s holdings had to have consistently increased their dividends every year for at least 20 consecutive years. SDY currently yields a market beating 2.33% and features many value stocks like Dallas's AT&T (NYSE:T).

The Bottom Line

As the market has swooned, so has stocks' valuations. That’s making many investors nervous. The key to navigating this environment is switching your focus from growth towards value investing. The previous ETF picks- along with the Schwab US Large-Cap Value ETF (Nasdaq:SCHV)- make adding a dose of value to a portfolio easy.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

Related Articles
  1. Investing Basics

    Does Active Value Investing Pay Off?

    Learn about a recently published paper that explores why active value investors underperform.
  2. Investing

    Introduction To Value Investing

    Find out what value investing is and how you can put it to work for your investment portfolio.
  3. Active Trading

    Value Investing

    Learn everything there is to know about value investing.
  4. Active Trading

    Value Investing + Relative Strength = Higher Returns

    Buying value stocks that are moving higher helps investors steer clear of value traps.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares US Basic Materials

    Learn about the iShares US Basic Materials exchange-traded fund, which invests in the equities of chemicals, metals and industrial gas companies.
  6. Mutual Funds & ETFs

    ETF Analysis: Ultra Oil & Gas

    Find out more about the ProShares Ultra Oil & Gas exchange-traded fund, the characteristics of the ETF and the suitability and recommendations for the fund.
  7. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  9. Investing Basics

    A Primer On Investing In The Tech Industry

    The tech sector can provide fantastic returns for investors with a little know-how in the field.
  10. Mutual Funds & ETFs

    3 Mutual Funds that Hold Google Stock

    Discover the top three mutual funds that dedicate the largest percentage of their total assets to Google, Inc. stock.
  1. Value Investing

    The strategy of selecting stocks that trade for less than their ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  5. Lion economies

    A nickname given to Africa's growing economies.
  6. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  1. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  4. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  5. What is the average return on equity for a company in the retail sector?

    The retail sector includes automotive; building supply; distributors; general; grocery and food; online; and special lines ... Read Full Answer >>
  6. How attractive is the food and beverage sector for a growth investor?

    The food and beverage sector is attractive for a growth investor. The sector's high degree of volatility means it tends to ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!