Is it time for value investing?
Value investing is traditionally very popular. It is concerned with finding stocks that are undervalued and the value of their shares do not represent this. For example, a company may have a high intrinsic value, in terms of its assets, intellectual property and revenues. Yet these are not represented in its share price. A value investor will invest in a company that is undervalued so that in the future the intrinsic value of the company will be reflected in the stock price. This can lead to a healthy return on investment.
The world economy is transitioning out of a period where central bankers around the world kept interest rates very low and engaged in the purchase of assets, especially corporate and sovereign bonds. Macroeconomic development in the past, after the Great Recession, meant that there was a great deal of liquidity in the markets. As a result, there was a great deal of money chasing assets, especially shares. This favoured stocks and shares that could grow rapidly, companies that had a high potential for growth became very popular.
The policies of the Central Bank created an ideal environment for growth investment. That is investing in companies that are growth orientated. This is one of the reasons why technology stocks have been doing so well in recent years. As a result, the environment was not really suitable for value investing. However as financial policy around the globe normalizes this is no longer the case. There are now more opportunities for value investing.
Value investing- the basics
This does not mean that there are a great many companies out there that have underperformed. However, what it does mean is that there is a move away from the momentum trade and now there is more investing being done based on the fundamentals. For example, growth is still as important as it was once, but it is not the only factor that needs to be considered when investing. Now balance sheets are becoming all important and reliable and attractive dividends are considered to be very significant. Here are some of the metrics that a value investor needs to heed and consider.
P/E ratio: Price per share/Earnings per share. This is how much earnings a company makes per share. A healthy P/E ration is in the ration of 14-16.
P/FCF ratio: This metric value’s the company based on its cash flow. If the company’s cash flow is not really represented in its share price then this should alert the value investor.
PEG ratio: This ration can help to understand the rate of growth of earnings and this shows the intrinsic health of a company, something that a value investor always needs to consider.
Debt/Equity ratio: The percentage of total liabilities that are on the balance sheet. Value investors are always wary of a lot of debt on the books this would restrict the ability of the company to generate payments and to pay dividends.
Why choose value investing
In recent years many value investors have not benefited as much as growth investors. However, value investing is a strategy that is suitable for some people. Many investors who are wary of stock market crashes and equity bubbles often prefer value investing. Then there are those who want a steady and a secure investment such as retirees and pension funds. In general, those who have longer time horizons prefer value investments.
If you want to move away from growth investing and want to engage in more value investing then a specific strategy needs to be developed. It will be necessary to diversify your portfolio. There will be a need to move out of companies with high revenues to those who have strong balance sheets.