By Mahavir Kaswa
Value investing is based on a simple premise—buying shares of companies that are trading at a “discount” to their fair value. As Charlie Munger put it: “All intelligent investing is value investing—acquiring more than you are paying for”.
Determining the fair value (or intrinsic value) of a company is a complicated task that relies on a set of assumptions to project how the business will perform in the future. Different analysts with their own set of assumptions may come up with different estimates of fair value for the same firm. Therefore, many value investing strategies rely on relative valuation ratios like price-to-earning (P/E) or price-to-book (P/B) to separate expensive companies (high P/E) from those that are available at a discount (low P/E).
Sharp turnaround since 2020
The value factor delivered lacklustre performance during the last decade as high-growth, asset-light businesses took centre-stage post the global financial crisis. However, there has been a sharp turnaround since the beginning of 2020 with the value factor showing outperformance of 10% CAGR.
Also Read: Senior Citizen Savings Scheme (SCSS), Post Office Fixed Deposit Interest Rates Hiked. Check details
The value factor tends to perform very differently when compared to the other factors — momentum, quality, and low volume. Data show that when every other factor underperforms the broad-based market, the value factor tends to exhibit strong outperformance. Therefore, it can provide a great level of diversification in your portfolio, providing an overall smoother investment journey.
Value shines during recovery
Historical data suggests that the value factor tends to outperform the broad-based equity when the market is staging a recovery after a crash. On an average, the market delivered 36.5% CAGR during recovery while the value factor delivered 45.1% CAGR — a staggering outperformance of 8%.
However, the value factor also significantly underperforms during market crashes to the tune of 8% CAGR. This means that value is highly sensitive to economic cycles and tends to amplify the positive as well as negative movements of the market. Therefore, value is considered a “pro-cyclical” factor.
In conclusion, investment strategies based on the value factor aim to buy stocks that are available at a “discount” to their fair value. This results in a pro-cyclical portfolio that is highly sensitive to economic cycles. Historically, the value factor has delivered stellar outperformance when the markets are recovering from a crash.
There has been a sharp turnaround since the beginning of 2020 with the value factor outperforming by 9% CAGR. It also performs very differently as compared to the other factors and can provide great portfolio diversification. Therefore, investors can look at strategies based on the value factor as a great complement to go along with their core portfolio.
The writer is vice president, Research, Motilal Oswal AMC
Buying cheap
The value factor tends to perform differently from momentum, quality and low volume
It is very sensitive to economic cycles
This strategy can lead to an overall smoother investment journey
