Most investors use either one of two primary strategies when it comes to investing – value investing or growth investing. Interestingly, the term ‘value investing’ is often used but not all investors understand the meaning of ‘value investing’.
What is value investing all about, and what are value funds and the benefits of investing in a ‘value fund’? When the Covid-19 pandemic spread globally and became the world’s largest health crisis, it stirred things up completely and left us with the question “Do value investing strategies remain relevant in these times?”
What Is Value Investing?
Value investing is a strategy that focuses on trading at a share price that’s considered to be a bargain for businesses with good fundamentals. The strategy involves selecting stocks that are undervalued compared to the industry average or their peers. The theory behind this approach is that the stocks of good companies will bounce back in time, if or when their true value is recognised by other investors.
A stock price may be undervalued because of an overreaction to market news, such as disappointing earnings, negative publicity or legal problems, all of which may raise doubts about the company’s long-term prospects. To determine the real value, value investors usually ignore the stock price and look at the entire company. They focus on the company’s fundamentals such as sales data, financial reports, holdings, real estate, patents, intellectual property, research and development, and many other factors. Value investing aims to exploit the irrational short-term behaviour of emotional investors.
What Is a Value Fund?
A value fund primarily invests in value stocks. Value fund managers will research and analyse a company’s fundamentals to determine if its stock is “good value” and should be purchased. However, it’s commonly believed that investors decide to buy into a fund based on the fund’s net asset value (NAV), which is incorrect. Investors should focus on macro-trends for the sectors in which the fund has invested.
Value investing is a long-term strategy, as it invests in companies with a high likelihood of generating a higher income to produce a sustainable cash flow. Thus, in a value fund, even if the stocks do not appreciate in value, the investor can benefit from dividends, if there’s high upside potential.
Market Review
The COVID-19 pandemic, followed by the movement control order (MCO) and a series of conditional movement control orders (CMCOs), disrupted many industries. A significant number of companies suffered as both their top line and their bottom line were affected. As people were unable to travel and were quarantined at home, business revenues dropped precipitously.
A lack of cash flow impacted the growth and performance of many firms, which was reflected in stock prices. Many investors, especially retail investors, resorted to panic selling which led to the market plummeting much faster compared to previous crises.
Sectors like energy and banking, plus cyclical, such as automakers, aerospace and defence firms, insurance companies and building material suppliers, all suffered, as they’re sensitive to economic cycles. Investors are currently weighed down by concerns that COVID-19 would persist, unemployment would remain high, interest rates and inflation would stay low, and dividends would not recover.
As a result, they shortened their time horizons. They piled into secular winners and avoided cyclicals. Fear and uncertainty also meant that investors favoured well‑understood growth stories during the recovery rally without considering valuations. Growth stocks, supercharged by low interest rates, digitisation, working from home and other pandemic-related trends, were continuously bought up which drove the market higher.
However, while the circumstances clouding the market were dark, falling prices created opportunities for fund managers to buy undervalued stocks. As mentioned earlier, a value investing strategy aims to benefit from the irrational behaviour of emotional investors. This is because fear and greed remain ever present and frequently lead to poor investment decisions based on perception and emotion rather than reality. For example, on March 15, 2020, the FBM KLCI slumped to its lowest level since December 2011, due to the second wave of Covid-19.
2021 Economic Recovery – The Benefits of a Value Investing Strategy
Growth should accelerate as the vaccine becomes widely available, allowing consumer, work, leisure and travel habits to return towards more sustainable levels. If the vaccination programme is effective, it will help drive economic recovery, which should favour the cyclical parts of the market. Furthermore, the expansionary government policy may see unemployment drop sharply and the bull market may keep running, with the COVID-19 losers likely to be the first to benefit.
China is a great example of how a recovery scenario could potentially play out globally. Their aggressive efforts to control the Covid-19 pandemic in the early days of the crisis were widely scrutinised, but the country’s heavy-handed approach paved the way for it to be largely Covid-free by the second half of last year. Consumer spending, car sales, and economic growth have all bounced back strongly from the depths of the pandemic back in March.
Certain sectors, such as airlines, energy, banking and other value sectors, may not recover in 2021, as the demand for their goods and services may not pick up until 2022. However, the stock market is forward looking and pricing in an anticipated recovery. These sectors may do better in 2021 than the economies in their respective states. Moreover, comparisons of corporate earnings could become more important in 2021. Many value cyclicals will have an easier time beating their dismal 2020 figures, unlike growth companies, which have a much higher bar for impressing investors.
The Bottom Line
The road to a post-COVID-19 ‘new normal’ will not be smooth. Investing during uncertain times can make an investor anxious and fearful, but even in good times, it can also be challenging. Investing successfully depends on being able to control and manage the risks without skipping the possible returns. This pandemic is having a significant impact on both value and growth stocks in the short term and long term. The most popular value investing strategy is diversification, which is designed to create a high safety margin.
About the author
Joe Tiong is a certified financial planner and she can be contacted at [email protected].
