Hit the jackpot with value investing

Among the numerous strategies conceptualized for stock selection, over the years, two strategies have emerged to be among the most popular – growth investing and value investing. Both these investment styles are based on a stock’s P/E multiple. The key difference between the two is the price at which the stock is available. While a growth stock will be available at a relatively higher P/E multiple, a value stock will be available at a low P/E with the potential of significant gains over time.

About value investing

Value investing is an investment strategy that seeks to buy stocks of companies that have been undervalued by the market. The basic theme of this investment strategy is buying stocks at less than their intrinsic value as it generally involves buying securities whose shares appear underpriced by fundamental analysis. Value investing focuses on the business and its fundamentals rather than external influences on the stock’s price. It does so as it believes that the market overreacts to good and bad news, resulting in stock price movements that are not in sync with the company's fundamentals. The result is an opportunity for investors to profit by buying when the stock is under-priced.

Genesis

Benjamin Graham is considered the father of value investing. He along with David Dodd, both professors at Columbia Business School advocated the concept of ‘Margin of Safety’ which is the cornerstone of value investing. This concept was first introduced in Security Analysis, a book co-authored by them in 1934. Margin of safety is the difference between the market price and the calculated (intrinsic) value of the stock.

Recognizing value stocks

Recognizing a value stock is the key to value investing. There appears to be some confusion even among fund managers in recognizing value stocks. For instance, if a stock available at a P/E multiple of say 15 a value stock,to recognize true value, one needs to take a step back and ask oneself, ‘based on the stock’s fundamentals, am I getting say, Rs 100 worth of assets at say, Rs 70?’ If the answer is Rs 100, one then one has spotted a value stock. Usually value stocks are available when an unexpected event occurs in the market. As against this, stocks suitable for growth investing would be available at a reasonably high P/E multiple but with the potential of growing faster than the overall market growth over a period of time. However, since the margin of safety is compromised in this case, the risk levels move up.

Value investing in India

The proportion of assets in Value Funds and Growth Funds is nearly equal, globally. But in India, the proportion of assets in Value Funds is merely 10 per cent of assets invested in Growth and other strategies. While most investment gurus would proclaim India to be a growth market where growth investing is the most suited investment style, the truth is that Indian markets offer a good opportunity for value investors. The basis for this view is that the investing strategy is not impacted by the type of market but by factors such as market sentiment, knowledge levels, industry life cycles, etc.

Value investing – a compelling opportunity today

The following reasons make the Indian markets attractive for value investing strategy:

1. Economic indicators are set to turn positive. The CAD, which is estimated at 2.5% of the GDP is no longer a concern; the Rupee has remained stable; inflation has eased off.

2. With the general elections round the corner, a pro-growth government will facilitate economic growth with its positive and progressive regulations.

Value picking is an art which is acquired with long term investment experience. For retail investors, it makes sense to use the mutual fund route to adopt this investment strategy.

In conclusion, value investing focuses more on the investor’s cost; lower the cost, higher the margin of safety. The key to profit from this investment style is to stay with the investment for the long term.

(The writer is MD & CEO, ICICI Prudential AMC)

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