Value investing strategies are delivering superior returns in a time where low returns are plaguing the market. Many investors are now looking outside the scope of growth orientated investments and fund managers in order to both diversify against any downside on their portfolios and in turn have greater potential to the upside when it is presented in the market. All in all, over the long term, low priced ‘value’ companies tend to outperform higher priced growth companies.
What is value investing?
Value investing can be described as an investment strategy where stocks or equities are selected which trade on a market (examples include ASX200 and S&P500) for less than their intrinsic value (true value). Intrinsic value can be defined as the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. Investors who use this method of investing believe markets overreact to good and bad news, resulting in stock price movements which do not align with a company’s long-term fundamentals – this allows for an opportunity to profit when the price is deflated.
What actually is a value company?
There is no particular industry or market where value companies sit. A value company can change and become a growth company. Vice Versa a growth company can become a value company. Many companies who are undervalued and therefore have a higher intrinsic price than is related as their stock price are found in the bottom third of the market. Some of these are often less reputable companies and possess much the same fundamental growth data as those of bigger and more publicised companies. However, value stocks can be found in any quartile of the market.
An example of a value company is as follows:
During the dotcom boom, unloved resource companies like BHP would have been value companies. However, during the subsequent resources boom, the price of BHP would have been bid up to move it out of value and into growth. Buying BHP cheap when no one thought it sexy and selling it when it was for a premium is how a value strategy can outperform. BHP’s share price in 2000 was $7 and in 2007 it breached $40.
How does it work?
Undervalued stocks present themselves as a result of investor irrationality. Traditionally, value investors look to take advantage of this irrationality by selecting stocks with lower than average price to book (P/B) ratios, lower than average price to earnings (P/E) and/or higher dividend yields. These measures are used to compare a company’s intrinsic value. If these measures show the company’s stock price is undervalued than value investors look to take advantage of this by purchasing stock.
The difficult issue facing value investors is the determination of a company’s estimated intrinsic stock price. Often different investors will determine a company’s intrinsic stock price differently when given access to the same data and information as each other. It is this factor which can influence an investment decision which is why value investor often leave a ‘margin of safety’. Put simply, they must buy an equity or stock with a big enough discount that it warrants making the investment decision, as it will allow for some error in the determination of the company’s intrinsic stock price.
Value investing is subjective as some investors in this space only analyse current assets and earnings figures to determine a value of a company whilst ignoring any future value growth potential. Conversely, other value investors only use future estimations of growth and cashflows to determine their pricing. Although different strategies exist, the underlying logic is that a value investor should purchase something for less than he thinks it is currently worth.
How has previous market conditions affected value investors?
In recent years, the equity market has been largely stagnant with not particularly much movement apart from events in the market such as Brexit and the US election most recently. During recent years as the market has been stagnant many investors have become more capital protection orientated in their investment mindset as investment returns across the market have underperformed. Caused by the shift in investor behaviour towards more defensive, high yield growth stocks. However, this changed six months ago, when oversold energy and materials company’s rebounded.
More recently the US election and Trump’s appointment as president has seen this trend continue to be favoured. Technology company’s in particular who were previously trading on vulnerable high price-to-earnings ratio’s (P/E’s) have since weakened.
Do you want to add value to your investment? Call Total Advice Partners today and speak with one of our financial advisers about how we can assist you to achieve your goals.
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