Time to warm up to value investing

Nimesh Shah Posted online: Monday, Oct 28, 2013 at 0000 hrs
Who isn’t fond of a good bargain? But a bargain does not necessarily mean getting things for cheap and ignoring quality; rather it is deriving utility from the money spent. Same is the case with value investing. It is not merely buying stocks at a discount but buying underpriced stocks that have an intrinsic potential to give big returns in the long run.

The value investing strategy focuses more on the fundamentals of the business and the company rather than the external influences on the stocks price. External influence is not so important in this case as markets overreact to good and bad news, resulting in stock price movements that are not in sync with the company’s fundamentals.

Benjamin Graham is considered as the father of value investing. He along with David Dodd, both professors at Columbia Business School, advocated the concept of Margin of Safety which is the cornerstone of value investing. This concept was first introduced in Security Analysis, a book co-authored by them in 1934. Margin of safety is the difference between the market price and the calculated (intrinsic) value of the stock.

While value investing is an opportunity for investors to profit by buying the stock when it is underpriced, it is not just laying your hands on every undervalued stock in the market. One has to consider several factors to judge the underlying value of the stock. Important stock indicators considered for value investing are price to earnings (PE) ratio, price to book value (PBV) ratio, PE to projected growth in earnings ratio or PEG ratio, and dividend yield.

While for dividend yield, the higher the number the better it is, for the remaining factors, the lower the number, the better it is.

Besides, when it comes to value investing, the importance of analysis cannot be overemphasised. Significant analysis must be done prior to investing such as reconciling market value and book value as well as estimating intrinsic value. This is important as investments are necessarily for the long term. One has to be on top of the market to rightly determine what is causing the gap in price and value of the stock.

But all investors are not equipped to handle the analysis on their own. Investing is an art, more so in equities, due to its inherent volatility. To avoid making a wrong decision, investors can choose the mutual fund route for investing in value funds, thereby benefiting from professional fund management.

Key benefits of investing in value funds

Asset Allocation: A critical aspect of financial planning is right asset allocation, better known as diversification. While it is more common to diversify the investment across various asset classes (equity, debt, gold), you can also reduce portfolio risks by diversifying your investment style between growth (investing in proven companies and sectors that would grow) and value (investing in unacknowledged fundamentally strong companies available at very attractive prices).

Downside protection: Value investing hinges on investing in undervalued but fundamentally strong companies. This helps reduce the risk of loss in the long term due to this built-in margin of safety. Also, typically, the decline posted by value stocks is less in a bear phase vis-ŕ-vis that posted by growth stocks. One must also keep in mind that while these funds are better off in a bearish phase, they may lag the market in a bullish phase as they invest in undervalued stocks and not high growth stocks. The exception, however, would be those stocks which get re-rated from value to growth once they are discovered by the market at large. The unlocked value from such stocks provides a significant upside.

India gradually discovering the merits of value investing

Value investing is one of the most popular investment themes globally. For instance, AUMs of Value Funds in the US is approximately 85 per cent of the AUMs of Growth Funds. As against this, in India, AUMs of Value Funds is merely about 10 per cent of the combined AUMs of Growth Funds and funds applying other strategies. While most investment gurus would proclaim India to be a growth market where growth investing is the most suited investment style, the truth is that Indian markets offer a good opportunity to use value investing.

Current scenario apt for value funds

We are in an interesting period for investment in Indian equities. We are going to approach the elections and the corporate results for this quarter. In our view, the quarterly results are not likely to be good. Having said that, if we take the long term view, whenever we have been in a situation where GDP growth is low, investing in equities during this period has historically proven to offer good returns.

For instance, 2001-02 and 2002-03 were years of low GDP Growth which offered a good investment opportunity yielding attractive returns. As against this, 2007-2008 and 2009-2010 were the best years to sell equities and book profits. On that basis, the current scenario appears to be a good time to look at value opportunities based on investing for the long term.

Value makes eminent sense considering the fact that currently, there are only about 10-12 stocks which are overvalued. The rest of the market is available at extremely attractive prices. Most fundamentally strong stocks are available at single digit PEs (price to equity) and with price to book below one. We think value is a far bigger opportunity than any other theme at this point of time.

While global challenges will need to unfold based on measures taken by administrations of other countries, domestic challenges, the most compelling one of which is continuation of the reforms process, will crystallize post the 2014 union elections. The positive aspect to the elections in terms of reforms is that both parties, the current government in rule and the opposition, have understood that reforms have to continue in order for the country to retain and nurture foreign interest in the form of FDI and other investment inflows. Hence, using the value strategy in the current scenario makes compelling sense.

The above reasons clearly indicate that the current scenario is apt for locating through sound research value stocks. A better option would be to invest in professionally managed value-styled mutual funds. They would not only help capture the upside that the underlying stocks offer when the market phase changes for the better but would also cushion the downside in a volatile phase.

To conclude, one may recall what investment guru Warren Buffett once said, “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” which probably best sums up the essence of value investing.

The right value

Value investing hinges on investing in undervalued but fundamentally strong companies. While value investing is an opportunity to profit by buying the stock when it is underpriced, it is not just laying your hands on every undervalued stock

Important stock indicators considered for value investing are PE ratio, PBV ratio, PEG ratio, and dividend yield. While for dividend yield, the higher the number the better it is, for the remaining factors, the lower the number, the better it is

The current scenario appears to be a good time to look at value opportunities. We are going to approach the elections and the corporate results for this quarter, in our view, are not likely to be good

The right value

* Value investing hinges on investing in undervalued but fundamentally strong companies. While value investing is an opportunity to profit by buying the stock when it is underpriced, it is not just laying your hands on every undervalued stock

* Important stock indicators considered for value investing are PE ratio, PBV ratio, PEG ratio, and dividend yield. While for dividend yield, the higher the number the better it is, for the remaining factors, the lower the number, the better it is

* The current scenario appears to be a good time to look at value opportunities. We are going to approach the elections and the corporate results for this quarter, in our view, are not likely to be good

The author is MD and CEO of ICICI Prudential