Even after two down years, in 2000 and 2001, mutual fund investors who own value funds have more than held their own. In 2001, small-capitalization value funds gained over 17 percent and mid-cap value funds returned more than 6 percent, according to Morningstar Inc., Chicago. Although large-cap value funds were down 5.4 percent, they lost only half as much as the average domestic stock fund, which fell by nearly 11 percent.
Moreover, in 2000 all types of value funds had positive returns. Small-cap value funds, which suffered losses as recently as 1998, gained more than 18 percent in 2000. Thus, during the longest bear market since the 1970s, small-cap value funds returned nearly 40 percent in two years. How can you tell whether a fund really is a value fund? Morningstar analyzes each stock held by each fund, by these two criteria:
Price-to-earnings ratio. The stock’s price is compared to its earnings for the previous 12 months. If two companies earned $2 per share, for example, the one selling for $20 per share would have a P/E ratio of 10 while the one selling for $60 would have a P/E ratio of 30. The one with the lower P/E ratio (the $20 stock, in this example), is more likely to be a value stock.
Price-to-book-value ratio. Also known as price/book, this ratio compares a stock’s trading price with its net worth per share, as reported on its balance sheet. Again, the lower the P/B ratio, the more likely a company’s shares will be considered a value stock.
Once these calculations are complete, Morningstar adds the two ratios and compares the total to a median number. If the total is at least 12.5 percent more than the norm, the fund is a growth fund; if it’s at least 12.5 percent less than the norm, it’s a value fund. Everything in between is a “blend” fund.
For example, Morningstar recently reported that MFS Emerging Growth Fund’s holdings (Oracle, Cisco Systems, etc.) had a P/E ratio of 33.3 and a P/B ratio of 6.0, so it was firmly in the growth fund camp. Dodge & Cox Stock Fund, on the other hand, owned companies such as Golden West Financial and Dow Chemical, with an overall P/E ratio of 19.3 and a P/B ratio of 2.6, so it’s classed as a value fund.
