Value Investing
In the world of investing, various studies have empirically demonstrated the advantage of pursuing value investing. Value investing strategies have had a long and storied history in financial markets. Despite this, there remains much confusion about value investing.
Value investing is simply buying something for less than what it is worth. It’s easy to see why value investing should work: buying stocks for less than their intrinsic value should naturally produce results. Value investing is simple and easier to understand but difficult to practice.
To better illustrate, envision going shopping at a mall and noticing a few stores have large banners and labels with the words “SALE 50% OFF” written in large, bold letters. An investor will get attracted to the SALE & buy products which are available at discount from the regular price. Similarly, a value investor would look for undervalued stocks with the assumption that it’s a better deal.
Markets: sasta & mehenga
Indians are known as value buyers, and this trait is reflected not there in just purchasing habits but also in their approach to the stock market. When Indians consider investing in the stock market, they do not simply jump into it without evaluating the market conditions. Instead, they carefully analyse whether at a given point the market is sasta (cheap) or expensive (mehenga) before making their investments.
However, Investors get confused between a lot of versions available under value investing like deep-value investing, contrarian investing, value factor investing.
Is value investing and value factor investing the same?
A value investor will look at individual stocks which are trading below their intrinsic value which is determined by company’s financial health or potential for future profits of a company.
While value factor investing is looking for particular fundamental characteristics of the stocks that make them likely to be undervalued. Value factor investing employs a systematic rule-based approach to identify securities with specific characteristics like low price-to-earnings, low price-to-book value etc.
Value factor indices – Cheaper than market
There are rule-based value factor indices available which select stocks based on various metrics like Price-to-earnings, price-to-book & price-to-sales. A price to earnings (aka PE) ratio is widely used to identify relative value of stocks or indices. A PE of 20x means for every Rs.1 of earnings an investor is paying 20 times in terms of price. It is used to compare and identify whether the stock or an index which represents the market is overvalued or undervalued.
With emergence of passive investing, indexing world has seen lot of new innovative indices (benchmarks) being launched over last 10 years. Among them is ‘S&P BSE Enhanced Value index’, it offers to provide exposure to value stocks. Let’s compare the price-to-earnings ratio of a value-based index i.e., S&P BSE Enhanced Value index with the flagship index Nifty 50.
Source: Niftyindices, S&P BSE. Data as of 31-Dec-22.
As we can see, the flagship index Nifty 50 has a price-to-earnings ratio of 22x while the S&P BSE enhanced value index has a price-to-earnings ratio of 7x. This indicates that the value index is 68% cheaper than the Nifty 50 in terms of relative value.
Value: Another leg higher
Over the 10-15 years, Value has been underperforming not just in India but globally. This led to number of market experts wondering if value investing is dead? However, over last couple of years Value noted strong comeback with stellar outperformance to broad-based benchmark.
Source: https://www.msci.com/www/blog-posts/the-value-factor-marks-a-decade/0313945437
The two conflicting articles within a brief period illustrate the market’s cyclical character. Value has indeed had trouble generating returns in the last many years. Various explanations have been put out for value factor’s underperformance, including the low interest rates.
In response to the covid-19 crisis, central banks around the world had implemented monetary policies aimed at increasing liquidity in financial system. This has led to historically low interest rates and increased availability of credit, which has in turn led to higher valuations for growth-oriented companies. As value tends to favour companies with lower valuations, this may explain why Value strategies had struggled in past few years.
Value factor strategies tends to perform well in high inflation and rising interest rates period as current earnings of companies tend to become more valuable making them attractive to investors. At the same time, the future earnings of growth stocks become less valuable, causing investors to shy away from them. This dynamic can lead to a shift in investor preference towards value stocks, resulting in higher returns for value strategies.
Overall, there are many potential factors that may contribute to value investing under performance. However, it is important to remember that investing is a long-term game, and past performance is not always indicative of future results.
Despite long term under performance by Value, many investors following multi-factor (e.g. – quality, value, low vol, and momentum) approach includes Value in their allocations, given historically very low correlation of value with other factors.
Conclusion
- After underperforming since the 2010s there has been a sharp turnaround changing the narrative from ‘Is value investing dead’ to ‘Value factor topping the charts’ based on the recent stellar performance.
- Value strategies perform well during rising interest rates and high inflation periods.
- Investing in a value factor strategy helps diversify risk in a traditional portfolio of broad-based indices.
- It’s easier and simpler for an investor to take part in the recovery by taking exposure in value factor ETFs or index funds.
Motilal Oswal Mutual Fund offers investors opportunity to take exposure to the ‘Value’ through its Index Fund and ETF: –
https://www.motilaloswalmf.com/mutual-funds/motilal-oswal-s&p-bse-enhanced-value-index-fund
Disclaimer: Mint, NSE, S&P BSE, twocenturies investments. The above graph/table is used to explain the concept and is for illustration purpose only. It should not be used for development or implementation of any investment strategy. Sectors – Macro Economic Sectors as per AMFI Industry Classification. The stocks/sectors mentioned above are used to explain the concept and is for illustration purpose only and should not be used for development or implementation of an investment strategy. The stock may or may not be part of our portfolio/strategy/ schemes. It should not be construed as investment advice to any party. Past performance may or may not be sustained in future. This article has been issued based on internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The indices mentioned herein are for explaining the concept and shall not be construed as investment advice to any party. The information/data herein alone is not sufficient and should not be used for the development or implementation of any investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this article are as of date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken based on this article. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
