Rejuvenated Value Stocks Could Change Fund Picture.

IN recent years, "value" investors have been beaten into the ground. The kids all laughed at them on the playground. "Growth" investors kicked sand in their eyes.

Now, those tattered egos are starting to revive. So far this year, the value half of Standard & Poor's 500-stock index has gained 5.7 percent, according to Morningstar, while the growth half has declined 9.4 percent.

A value investor bets on stocks whose prices are depressed. Maybe the industry has problems. Maybe the company made some mistakes.

Either way, value stocks are low-priced, compared with various measures of what the company might be worth. Investors expect the company to turn around. If it does, the stock should soar.

How cheap the stock price really is depends on how you measure value. For example, take the price/earnings ratio, which compares the stock price with current or projected earnings per share.

The average S&P stock is selling for 25 times projected earnings today. Value investors prowl for promising stocks whose P/Es fall well below that average.

By contrast, growth investors look for companies whose earnings and stock price are growing fast. Their P/Es are typically well above average. As long as future profit growth looks strong, these stocks rise even more.

During the 1970s and '80s, value stocks generally captured the performance derby. But starting in the early '90s, growth stocks left value stocks in the dust.

Might the climate change?

"The first sign that a particular investment style might be coming into vogue is that its techniques stop killing those who practice it," says analyst James Bianco, writing for The Leuthold Group in Minneapolis.

When the economy moderates (or is perceived to be moderating), value does better than growth, Bianco says.

Still, stock prices remain relatively high. So far, Bianco sees only three groups with excellent values today: aerospace/defense, managed health care and health care facilities.

If we indeed undergo a shift to value stocks, many investors will have to rethink the way they choose their mutual funds. Often, you go by the stars -- that is, the stars awarded by Morningstar, which tracks and analyzes mutual fund performance.

Morningstar rates funds according to past performance and level of risk. The top performers get five stars, the lowest performers, one star. Every rated fund has been in business for three years or more.

Stars are widely used as a sales tool. Five-star funds tout their status in ads, and investors pile in.

The five-star U.S. equity funds today are overwhelmingly growth funds. If you spread your money over three or four of the best, you have not diversified. They're all buying the same kinds of stocks.

Mark Warshawsky, director of research at the TIAACREF Institute (that's the giant teachers' pension fund) has just published an analysis of recent Morningstar ratings. He found that, during 1998 and 1999, only about one-third of the five-star or four-star mutual funds stayed in those upper ranks. At some point, the rest fell to three-star level or below.

The drop could reflect recent underperformance. Maybe the fund's stocks are falling out of favor.

Alternatively, the fund might have had a great year in 1997, but that year just dropped out of Morningstar's three-year performance measure. In this case, maybe its stocks weren't as strong as you thought, when you bought in 1998.

The longer a fund has had a high rating, the less likely it is to drop down, Warshawsky says. Funds have a slightly better chance of remaining in the top ranks if they've been there for at least 10 years.

There' s more slippage among the younger funds -- and those funds, in particular, are more apt to emphasize growth today.

John Rekenthaler, Morningstar's research director, says there's actually not much difference between mid-ranked funds and top-rated ones. Three-star, four-star and five-star funds have been found to perform pretty much alike, he says.

Still, those funds do better, on average, than two-star or one-star funds. If that's the case, you shouldn't worry if your fund moves from level to level, as long as it rates three stars and up.