Three value stock picks from a veteran manager with a good performance record

By Philip van Doorn

John Bailer of Newton Investment Management names three companies whose stocks seem ripe for the plucking

For many years through 2022, it was becoming more difficult for active fund managers to make the case for their services, when broad index funds, with lower fees, were performing so well. But the tech-driven market decline for 2022 might have made some investors think again about different investment styles for the long term.

One approach that has performed well over the years has been that of the BNY Mellon Dynamic Value Fund DAGVX, which is co-managed by Brian C. Ferguson (the lead manager since 2003), John Bailer and Keith Howell. The fund was established in 1995. Bailer became one of the fund's managers in 2004 and Howell in 2021. The managers work for Newton Investment Management North America, which is a subsidiary of Bank of New York Mellon Corp. (BK).

During an interview with MarketWatch, Bailer named three stocks held by the fund that he believes are standout bargains for investors right now.

The BNY Mellon Dynamic Value Fund has $3.5 billion in assets under management. It typically holds about 75 stocks selected from the components of the Russell 1000 Index RUI.

The BNY Mellon Dynamic Value Fund fund has a five-star rating (the highest) within Morningstar's "Large Value" fund category. Information about the fund's performance and a list of its top holdings are below.

The fund's largest holding is Berkshire Hathaway Inc. (BRK.B), which made up nearly 4.5% of its portfolio as of Sept. 30. Bailer said he agreed with Berkshire CEO Warren Buffett's philosophy of "not being macro predictors."

"We select on a company-by-company basis," he said. "We look for catalysts and intrinsic value."

Bailer suggested readers review Buffett's letters to shareholders "in the late 70s and early 80s -- the last time we had high inflation."

Bailer paraphrased Buffet as saying "you want companies that can generate their own free cash flow." That means that in this market environment, utility companies and real-estate investment trusts that have to borrow money to maintain high dividend payouts, can be expected to underperform because their borrowing costs are rising after being low for decades. "You want companies with low capital intensity, high returns on invested capital and free cash flow," he said.

For a deep dive into Buffett's philosophy and links to his letters, read: Why Warren Buffett has done more to educate investors than any other corporate executive

Three value stocks

"We believe in combining intrinsic value with momentum (earnings, price or business catalyst) and strong quality fundamentals, Bailer said. "We want to combine all three characteristics to avoid a deep value trap."

An investor can fall into a value trap by being focused on stocks with low prices to expected earnings or book value, or by emphasizing those with high dividend yields. A low valuation may not be a temporary phenomenon. While screening for financial quality, the Newton Investment Management team also needs to feel confident a company's business is on the right track.

Here are the three holdings of the fund that Bailer highlighted.

JPMorgan Chase

Shares of JPMorgan Chase & Co. (JPM) have returned 11% this year, while the KBW Nasdaq Bank Index BKX has fallen 22%, reflecting investors' concerns about the industry's rising cost for deposits and slow lending volume. Rising interest rates have pushed bond prices lower, which has reduced the value of the banks' securities portfolios. The combination of those declines and the rising costs for deposits helped lead to three regional bank failures earlier this year.

But JPMorgan Chase managed to increase its third-quarter net interest income (interest revenue less the cost of deposits and borrowings) to $22.7 billion from $17.5 billion a year earlier. That was a 30% increase, and if JPM's acquisition of the failed First Republic Bank of San Francisco were excluded, net interest income still would have jumped 21%, according to the bank's earnings press release.

Bailer cited that core strength, the bank's low valuation to expected earnings and CEO Jamie Dimon's "very conservative" style for managing the bank. As regulators fine-tune a set of strong capital requirements for large banks, Bailer believes JPM is in a good position because its capital ratios are already "consistent to where we see the regulations going."

Medtronic

Medtronic PLC (MDT) makes various devices used in medical therapies and for surgeries. Bailer said the widening adoption of GLP-1 medications for weight loss and diabetes therapy had some investors concerned that the need for certain surgeries could be reduced over the long haul. But that is the sort of development that has provided "the opportunity to purchase a high-quality stock at a discounted valuation," he said.

"These weight-loss drugs are game-changers," Bailer said, but he also believes investors have been too negative about Medtronic's prospects. One point that he made was that some patients who need surgery may need to lose weight first. So use of GLP-1 drugs is not necessarily a negative for the company.

For more about GLP-1 medications, check out Eleanor Laise's interview with Daniel Skovronsky, Eli Lilly & Co.'s chief scientific officer.

Bailer said that earnings estimates for Medtronic had been rising "for the first time in several years." Medtronic's stock trades for 13.7 times the consensus 12-month earnings estimate among analysts polled by FactSet. That compares to a five-year average forward price-to-earnings ratio of 18.5, and to the S&P 500's current forward P/E of 18.2.

Constellation Energy

Bailer called Constellation Energy Corp. (CEG) "a renewable energy stock masquerading as a utility."

Technically Constellation is an electric utility that was spun-off by Exelon Corp. (EXC) in February 2022. Constellation bills itself as "the nation's largest producer of carbon-free energy," adding in its most recent annual report that its annual electricity output was "nearly 90 percent carbon-free."

Bailer said that the company has "low debt service," unlike many other utility companies and that its nuclear and hydrogen energy business can benefit from the Inflation Reduction Act, which President Joe Biden signed into law in August 2022.

He added: "We believe spin-offs work well. They tend to be undervalued."

Fund performance

Here is how the fund has performed against its benchmark, the Russell 1000 Value Index RLV, and against the iShares Russell 1000 Value ETF IWD, which tracks that benchmark. The table also includes returns for the S&P 500 SPX and for the SPDR S&P 500 ETF Trust SPY, which tracks it.

First, here are year-to-date total returns, those for 2022, from the end of 2021 and for some longer periods. (All investment returns in this article include reinvested dividends.)

     2023  2022  From end of 2021  3 years  5 years  10 years  15 years 
   BNY Mellon Dynamic Value Fund Class A      5%    3%                8%      62%      65%      164%      435% 
   Russell 1000 Value                         1%   -8%               -7%      30%      36%      114%      329% 
   iShares Russell 1000 Value ETF             1%   -8%               -7%      30%      35%      111%      319% 
   S&P 500                                   16%  -18%               -5%      31%      70%      203%      534% 
   SPDR S&P 500 ETF Trust                    16%  -18%               -5%      31%      69%      200%      523% 
                                                                                               Source: FactSet 

The fund's returns are net of annual expenses that come to 0.93% of assets under management for its Class A shares. For SPY the annual expense ratio is 0.095% and for IWD the expense ratio is 0.19%.

The fund has been the best performer for three years because it had a positive return in 2022, when the S&P 500 dropped 18%. It has beaten its benchmark handily for all periods, but has trailed the S&P 500 significantly for 10 and 15 years.

Now let's add two more periods to the long-term lookbacks:

     3 Years  5 Years  10 Years  15 Years  20 Years  25 Years 
   BNY Mellon Dynamic Value Fund Class A        62%      65%      164%      435%      476%      689% 
   Russell 1000 Value                           30%      36%      114%      329%      351%      351% 
   iShares Russell 1000 Value ETF               30%      35%      111%      319%      336%       N/A 
   S&P 500                                      31%      70%      203%      534%      517%      517% 
   SPDR S&P 500 ETF Trust                       31%      69%      200%      523%      507%      500% 

The BNY Mellon Dynamic Value Fund underperformed the S&P 500 when interest rates were unusually low. On the table you can see that it trails the S&P 500 for 20 years, which may not be unexpected because of the fund's value focus. But it has outperformed by a wide margin if you go back 25 years.

Top holdings of the fund

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11-08-23 1103ET

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