There is one thing that every Indian loves – getting a good discount. We are always on the lookout for discounts while shopping, trying to get the most bang for our buck. Almost everyone would agree that it is smarter to buy that new smartphone when it goes on sale, not when it is selling at full price. Why pay extra when you can end up enjoying the same set of features at a discount? Can we apply the same concept in investing as well?
What is Value investing?
Benjamin Graham, who is widely regarded as the “Father of Value investing”, popularized the concept in the 1930s. In fact, some of the world’s most renowned investors like Warren Buffet and Charlie Munger are practitioners of Value investing. Value investing is based on a very 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 widely different estimates of fair value for the same company. Therefore, many Value investing strategies rely on relative valuation ratios like P/E or P/B to separate expensive companies (high P/E) from those that are available at a discount (low P/E).
The Turnaround of Value
The Value Factor delivered lackluster performance during the last decade as high-growth, asset-light businesses took center 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. Similar trends are visible not only in India, but also in other markets around the world like the US where the Value Factor has historical data going back to the late 1920s that validates its long-term performance.
Value works when nothing else is
The Value Factor tends to perform very differently when compared to the other Factors – Momentum, Quality, and Low Vol. The graph above shows that when every other Factor is underperforming 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, it is important to note that 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. After the lost decade of Value, 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.
A short version of this article was covered by Financial Express on 30th September, 2022 – https://www.financialexpress.com/money/your-money-value-investing-can-offer-portfolio-diversification/2695756/
Author: Raghav Avasthi, Research Analyst, Passive Funds, Motilal Oswal AMC
Co-author: Mahavir Kaswa, Head of Research, Passive Funds, Motilal Oswal AMC
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