Value investing has cemented itself as one of the most popular and successful stock-picking methodologies adopted by investors globally. While growth stocks attract most of the limelight during bull runs, value stocks have historically delivered superior risk-adjusted returns over long time horizons. This investment style rests on a simple yet profound concept – buying stocks trading at valuations less than their intrinsic or ‘true’ worth.
In this blog, we will explore what value investing entails, discuss how to identify value opportunities and see why this contrarian approach can potentially earn higher returns compared to broad market indices.
What is Value Investing?
Value fund investing is an investment strategy popularised by legendary investor Benjamin Graham. It aims to identify and invest in stocks that are trading at prices significantly below their intrinsic values. The premise is that the stock price will eventually converge towards the intrinsic value, generating potentially healthy returns for patient investors.
Some key tenets of value investing include:
- Focus on intrinsic value: Value investors give more importance to a stock’s intrinsic value over its current market price. The gap between the two presents a margin of safety.
- Contrarian approach: Value stocks tend to be out of favour and underappreciated by the market. Their financial metrics seem unattractive in the short term.
- Long-term horizon: Value investing requires patience to allow the investment thesis to play out. Gains may potentially accumulate slowly before accelerating suddenly.
Identifying Value Opportunities
The first step entails developing a suitable valuation framework based on parameters like earnings, cash flows, assets, and dividends. Some commonly used valuation ratios are:
- Price to Earnings (P/E) Ratio
- Price to Book (P/B) Ratio
- Dividend Yield
The next step involves screening the market for stocks with lower comparative ratios than relevant industry peers. For instance, using in-depth research, Bandhan Sterling Value Fund focuses on identifying value opportunities across various market caps. With total assets under management (AUM) of ₹8,161 crores (as of January 2023), this scheme follows a value investment strategy since its launch in 2008.
Advantages of Value Investing
History shows value investing can generate excess risk-adjusted returns over extended periods, often rewarded through compounded growth. Some key advantages include:
- Cushion against downside risk – The intrinsic value acts as the margin of safety. Even if the stock price falls, value investors continue holding if business fundamentals remain intact.
- Higher upside potential – Value stocks have a potentially greater scope for price appreciation. As the crowd recognises the real worth, the stock can surge rapidly to bridge the valuation disconnect.
- Healthy long-term returns – Avoiding overpaying stocks preserves capital for opportunities, offering better risk-reward payoffs. Patience allows compounding to work its magic.
Conclusion
While habits like checking stock prices or quarterly financials are hard to shake off, value investing calls for a shift in mindset. This long-term, business-focused approach may help many investors amass enduring wealth. Identifying high-quality yet underpriced stocks through disciplined fundamental analysis may not appear simple. However, adopting a value investment framework may potentially aid investors in making better capital allocation decisions.