Four Funds That Look Cheaper Than the Market

Even with the stock market's retreat so far this year, the market still looks a bit rich according to some measures such as the cyclically adjusted price/earnings ratio, a favorite measure of economist Robert Schiller that my colleague John Coumarianos wrote about here. Other investors argue that the market actually looks undervalued based on different measures, but most managers agree that the bargains of a year ago are gone and that it's been hard to gauge the quality of corporate earnings in the wake of the crisis. In such an environment, it makes sense to veer toward portfolios with a built-in margin of safety, or lower valuations than the market.

Morningstar.com's  Premium Screener can uncover portfolios that look cheaper than the S&P 500 Index, using  Vanguard 500 Index Investor (VFINX) as a proxy. To do so, this screen focuses on stock funds whose portfolios, on average, have lower price/prospective earnings (forward P/E), price/book, and price/cash-flow measures than the proxy.

In this case, the screen is focused on mid-cap stock funds in addition to large-cap portfolios because a lot of go-anywhere funds that view the S&P 500 Index as their primary benchmark end up in the mid-cap categories by default. And so, the forward P/E measure for the typical mid-cap fund was roughly on par with Vanguard 500 Index Investor's at last count. The screen also narrows the field to funds with top-quartile category rankings for the trailing 10-year period. Manager tenures are set to 10 years or more, and the results are limited to reasonably priced funds that are open to new investments of $25,000 or less.

To run this screen yourself, click here.

Our proxy, Vanguard 500 Index, recently had a forward P/E multiple of 16.1, whereas mid-cap blend fund  Fidelity Low-Priced Stock's (FLPSX) was 12.4. The fund's P/B and P/C measures, clocking in at 1.3 and 3.9, were roughly half the proxy's. Manager Joel Tillinghast runs an eclectic portfolio with hundreds of holdings. His process involves using discounted cash-flow analysis to value firms and then buying when stocks are trading well below his fair value estimates. Over the long term, the fund's valuation measures have remained below that of the broader market, and its long-term record is topnotch.

The strategy at  Neuberger Berman Partners (NPRTX) is P/E-focused. Manager Basu Mullick won't buy stocks with P/E multiples higher than their respective industry averages, and he keys in on firms that are trading at historically low price multiples before analyzing the fundamentals of their businesses. So, the fund's forward P/E ratio clocks in at 13.8, with a relatively low P/B ratio of 1.4 and P/C ratio of 5.5. Because Mullick has long been bullish on commodities, the fund's outsized stake in energy and materials could hurt the fund if prices tumble again as they did in 2008. Still, the fund has done well enough in good times to make the bumpy ride worthwhile.

 Dodge & Cox Stock's (DODGX) management team zeros in on large-cap firms that look attractively priced on a variety of value measures. Recently, it sported a forward P/E of 13.6, P/B of 1.5, and P/C of 5.0. The team's valuation-conscious approach often leads it to beaten-down sectors, and it isn't afraid to load up. For instance, the fund's 23% stake in health-care firms was nearly twice the S&P 500's at last count, in part because the team believes negative news on patent expirations and health-care reform is already priced in. The fund's contrarian streak has gotten it in trouble at times, such as when it bought financials stocks going into 2008. The fund's process has produced a great record over the long term, though.

 Hodges (HDPMX) is a go-anywhere offering manned by father-and-son team Don and Craig Hodges. They like steadily growing firms with sturdy balance sheets and management teams that engage in shareholder-friendly practices. On average, the managers haven't been willing to pay up for faster-growers lately, as the fund's valuation measures came in just under those of the proxy. Although they are bottom-up investors, the managers' style has typically kept the portfolio focused on a few sectors. For instance, the 50-stock portfolio has sported heavy concentrations in the energy, industrial materials, and media sectors in recent years. These heavier weights in a few sectors can significantly impact performance (for good and bad) during the near term, but the managers' process has resulted in a strong long-term record versus mid- and large-cap funds alike.

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