Value-oriented mutual funds made a strong comeback amid the ongoing uncertainty in the market. During the year 2020, value stocks bounced back, rising 26 percent, as compared to an 11 percent rise for growth stocks1Through this post, we will learn the meaning of value investing strategy, what parameters does the value investor use to select stocks and what is the future of value investing?
What is Value Investing
Value investing is focused on finding value in stocks, belonging to businesses that are undervalued currently but have a good long-term potential.
How do value fund managers select stocks?
Value Fund Managers are actively trying to identify stocks that are undervalued and traded below their intrinsic value and believes that their future potential is better than the trend it currently reflects. They avoid the herd mentality and buy those stocks which are contrary to popular opinion.
The Margin of Safety is the most important principle used during stock selection, it is the difference between the price of the stock and what the fund manager believes is its intrinsic value.
The fund manager selects stocks which meet the trading volume value criteria. He then does a sector analysis and prepares detailed projections. He finally shortlists a portfolio with a broad exposure to various sectors.
The fund manager generally identifies such stocks using financial metrics such as the lower than average Price to Book Value (P/B), a lower Price to Earnings (P/E) ratio, Return on Equity (RoE), Return on Capital Employed (RoCE), debt-to-equity ratio or higher dividend yields to name a few.
A low P/E ratio indicates the price an investor is ready to pay for earnings per share of the company is lower than its peers in the broad market or its historical average
A lower than average Price to book (P/BV) value ratio refers to the company’s market value is lesser than its book value, only if P/BV is less than 1 relative to its peers and/or historical average
Stocks should have a catalyst in the foreseeable future.
Figure 1: Value investing process
Why have value investors underperformed the markets:
Value investing strategies sometimes tend to underperform the market temporarily due to several perceptions or positive or negative sentiments, leading to stock price movements that may not correspond with a company’s long-term fundamentals. This could occur when either markets are polarized or due to high liquidity, it does not appropriately price the risk
The future outlook
Though some stocks do not look cheap on a historical PE basis, certain sectors appear reasonable when looking at future valuations. Some of the value stocks may not pay off immediately (in the short-term and medium). In short, value investing is for the long-term.
If the fall in Covid-19 second wave continues, followed by momentum in the vaccination program across all age groups, then it is likely that economic recovery will pick up the pace and prove as tailwinds for Value investing. On the other hand, if the Covid-19 second wave continues to linger, GDP estimates and bond yields continue to decline, then the value investing strategy could continue its trend of underperformance for the near term.
In short, if corporate earning upgrades continue value is likely to outperform. If the markets move up only because of liquidity, value is likely to underperform
It must be noted that different investing styles perform differently across market cycles. Therefore, investors can consider value funds within a diversified equity allocation.
1 Joseph, Samrat. “Why 2021 Could Be The Year Of Value Funds.” MoneyControl , Why 2021 could be the year of value funds. Accessed 6 Jan. 2021.
Disclaimer: The views expressed here in this Article / Video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The Article / Video has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of the Article / Video should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. None of the Quantum Advisors, Quantum AMC, Quantum Trustee or Quantum Mutual Fund, their Affiliates or Representative shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary losses or damages including lost profits arising in any way on account of any action taken basis the data / information / views provided in the Article / video.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.