K V Prasanna, Partner, Marinawealth
Unlike beauty which firmly lies in the eyes of the beholder, the value of a product or service is firmly tethered to its price. When you pay a competitive price for a great product or service, you end up getting great value. And this is where lies the crux of value investing.
While there are several approaches to investing, value investing and growth investing hold significant sway in the market. You will be surprised to note that according to the MSCI India Value index, value style equities in India gained 32% in 2021 against 26% in 2020. Value style equities outperformed growth style equities by 23% in 2021.
What is value investing?
In its most basic form, value investing entails buying stocks of companies that are trading at a significant discount to their intrinsic value. Let’s take a step back. The intrinsic value of a company is simply the actual value of a company based on its assets and future cash flows. Ideally, the stock price of a company should reflect this intrinsic value and trade at or around those levels. However, there are times when a stock trades at a premium to its intrinsic value and then there are times when it trades at a discount to its intrinsic value. Value investors are concerned with the latter. Value investors look to invest in stocks that are trading at a discount to their intrinsic value in the expectation that over a period of time, the stock price will increase to reflect its true value.
There are several reasons why a stock might trade at a discount to its intrinsic value. The most common reason is a short-term profit disappointment. Often, a profit disappointment can result in a substantial fall in the price of the stock as investors react emotionally to bad news. Further, they also fear additional negative developments and tend to sell the stock. However, if the company is robust and has significant future potential, value investors will recognise that the fall in profits is only temporary in nature and will treat it as an opportunity to buy the stock at a discount to its intrinsic value. It is also important to understand that the absolute stock price is not the only measure of value. Investors assess various evaluation metrics like price to book value or price to earnings value which can give a good indication of how the price of a company compares to its book value or its earnings.
These factors can guide your value investing journey:
· Stay patient: The secret sauce to the success of value investors is “patience”. You will tend to change your decision and withdraw your money when stocks don’t perform well for years. But, to get real value out of your investment, you need to keep patience and overlook the market downfalls.
· Buy businesses, not stocks: If you invest in a company's shares, consider buying that business (even if it is only one share). This means ignoring all the market trends and volatility and staying invested even in low times. However, it would help if you put significant effort into deciding which business to buy or where to invest, as it will affect your returns massively.
· Seek margin of safety: Margin of safety is the difference between the intrinsic value and its current price. Note that the higher the margin of safety, the greater the growth in the stock price in the future and higher the cushion from volatility and stock price declines.
This brings us to the most important question, ‘Does value investing make sense in current times?”
Value investment has always been in trend and will always do. What changes is the pockets of value. Even though on a valuation basis, the Indian equity market is no longer cheap; but at all point in time there will be pockets where there is value. In 1999, old economy stocks were the value pockets, while in 2007, there was value in technology, pharma, and FMCG. In value style, investments made in 1999 did very well because markets were largely focused on technology stocks at that point in time. Similar was the case in 2007 when infrastructure was in focus. Hence, we believe that value investing when the market is elevated tends to do well as value focuses on investing in sectors that are out of favour but offer long-term value.
Value investing can help you meet your long term-financial goals and create exponential value for your portfolio.
