The Lead - When Cheap May Be Risky

Performance of Cheap Price to Book Stocks

Deep Value vs. S&P 500 Total Returns

A deep value stock is a company’s share trading at an exceptionally steep discount to its intrinsic or asset value. Bottom 10% P/B means a stock’s Price-to-Book (P/B) ratio is lower than 90% of other companies in a specific group. It indicates that the stock is highly undervalued relative to its net asset value. Data is as of 08.28.2026. Source: Bloomberg L.P.

Over the past few years, we have discussed how periods of market weakness can, in certain circumstances, create investment opportunities. This month we have actively debated a recommendation where the primary thesis point was that it was “cheap.”

Are we value investors? Yes, but value is but one of our four investment pillars. Our investment philosophy comprises not only value, but considerations such as the competitive advantage a company should have to maintain and grow their return on capital. Also, does the company have excessive debt adding to the risk of the position, and is there a clear path to future growth, or does outlook seem mainly based on the possibility that results will return to historical norms?

What’s the point for clients? Stocks that are cheap on valuation may be risk masquerading as a cheapness signal. In this scenario, there seem to be three main problems.

First, if returns on capital for cheap stocks tend to be just above their cost of capital, as seen in the second chart, there appears to be little room for error, hence risk as any growth could destroy value if returns on capital are below their cost.

Return on Equity Comparison

ROE: Return on equity. Data is as of 08.28.2026. Source: Bloomberg L.P.

The Cheapest Stocks on the Five-Year Assessments Generated the Least Returns

Data is as of 08.28.2026. Source: Bloomberg L.P.

Second, as seen in this chart, this group of stocks over the past five years has had a negative skew in terms of their risk profile. In other words, the cheapest stocks also appeared to generate weaker returns than the market over this period. We believe this may have contributed to their overall pattern of underperformance as seen below.

Finally, how long is an investor willing to wait for the potential classic revision to the mean to occur?

By focusing on our four pillars, rather than just one, we aim to minimize these concerns in our investment decisions. By focusing on companies with higher-than-average returns on capital, we seek to minimize the risk of not earning our cost of capital.

In terms of timing, while the value-only investor appears to wait for an event to close the gap between the share price and their view of intrinsic value, companies with high returns on capital may be better positioned to compound value year after year. Quality stocks are seldom cheap, and many times periods of unfavorable news may create opportunity. But in scrutinizing new investment opportunities, we believe that work needs to be done not just in valuation, but valuation combined with the quality of the business that can be owned over a long period of time.

As always thank you for your interest and trust managing your investments.

Disclosures

Past performance is not indicative of future results. Any type of investing involves risk and there are no guarantees that these methods will be successful. Economic charts are provided for illustrative purposes only. The information provided herein is subject to market conditions and is therefore expected to fluctuate.

The opinions contained in this presentation reflect those of Sterling Capital Management LLC (SCM), are for general information only, and are educational in nature. The opinions expressed are as of the date of publication and are subject to change without notice. These opinions are not meant to be predictions and do not constitute an offer of individual or personalized investment advice. They are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. All opinions and information herein have been obtained or derived from sources believed to be reliable. SCM does not assume liability for any loss which may result from the reliance by any person upon such information or opinions.

Investment advisory services are available through SCM (CRD# 135405), an investment adviser registered with the U.S. Securities & Exchange Commission (SEC) and an indirect, wholly-owned subsidiary of Desjardins Global Asset Management Inc., which is part of the Desjardins Group. SEC registration does not imply a certain level of skill or training, nor an endorsement by the SEC. SCM manages customized investment portfolios, provides asset allocation analysis, and offers other investment-related services to affluent individuals and businesses.

Sterling Capital does not provide tax or legal advice. You should consult with your individual tax or legal professional before taking any action that may have tax or legal implications.

The securities described are neither a recommendation nor a solicitation. Security information is being obtained from resources the firm believes to be accurate, but no warrant is made as to the accuracy or completeness of the information.

The volatility of an index varies greatly. All indices are unmanaged and investments cannot be made directly in an index.

The S&P 500^® Index is a stock market index weighted by market capitalization that is made up of 500 of the largest public companies in the U.S.

Technical Terms: The price-to-book (P/B) ratio is a financial metric that compares a company's market value to its book value, total assets minus total liabilities. Return on equity (ROE) is a financial performance ratio that measures how effectively a company uses shareholders’ equity to generate net income. It is calculated by dividing net income by average shareholders’ equity. A risk profile outlines an individual or organization's willingness and ability to take on financial risks, guiding their investment or operational strategies. (Technical definitions are sourced from Corporate Finance Institute and Investopedia.)

The Chartered Financial Analyst^® (CFA) charter is a graduate-level investment credential awarded by the CFA Institute, the largest global association of investment professionals. To earn the CFA charter, candidates must: 1) pass three sequential exams; 2) have at least four thousand hours of qualified professional investment experience; 3) join CFA Institute as members; and 4) commit to abide by, and annually reaffirm, their adherence to the CFA Institute Code of Ethics and Standards of Professional Conduct.

Since we began publishing The Lead in 2015, our primary purpose has been to communicate our investment philosophy and process as an investment advisor in the context of changing markets. In creating portfolios that differ from our benchmarks by focusing on characteristics that have a long term history of attractive relative returns according to Ned Davis Research, the portfolios are different from the benchmarks and as a result there can be periods where results differ including below benchmark performance. Since strategies are oriented toward the long term characteristics, if those characteristics are out of favor over a period of time, the given strategy’s performance could be challenged in terms of relative performance. While Sterling believes active professional investment management that employs a consistent process with a long term orientation and aligned with client interests offers benefits, management fees to support the active approach can be higher than certain alternatives. When hiring an investment manager we believe it is important to monitor the investment risks taken including sector concentrations, portfolio turnover, and the impacts of dividend policy changes.

About the Author

Charles Wittmann, CFA^®

Co-Portfolio Manager

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Charles Wittmann, CFA^®, Executive Director, joined SCM in 2014 and has investment experience since 1995. Chip is Co-Portfolio Manager of the Equity Income strategy. Prior to joining SCM, he worked for Thompson Siegel & Walmsley as a portfolio manager and (generalist) analyst. Prior to TS&W, he was a founding portfolio manager and analyst with Shockoe Capital, an equity long/short hedge fund. Chip received his B.A. in Economics from Davidson College and his M.B.A. from Duke University's Fuqua School of Business. He holds the Chartered Financial Analyst^® designation and served as President of CFA Society Virginia from 2012-2013.