The most common investment styles used today are value based investing and growth style investing. While most investors are generally familiar with these terms, having a deeper understanding of the mechanics will contribute to investment success. I’ll chat about value investing today and perhaps we can cover growth in a future piece.
When searching for value securities, portfolio managers seek out companies that are currently priced below their intrinsic value. To keep things as simple as possible, I will reference equities but value based investing could also be applied to the fixed income market.
A stock may trade below its intrinsic value for a number of reasons: the general market might not understand the underlying business, investors might not be privy to all of the company information, the particular industry could be experiencing a difficult time while the specific company is thriving, a generally unfavourable period for equity markets, etc.
The truth of the matter is that analyzing the balance sheets of companies to determine a company’s “health” is a difficult task. Few retail investors as well as a number of so called professionals have the skill or inclination to do so.
Value based investing is a game of patience; the reason a company is cheap today is because the rest of the market hasn’t noticed yet. It’s difficult to predict when investors might take notice, but fundamentals do prevail and eventually a stock’s price reflects its intrinsic value creating return for the knowledgeable, patient investor.
Most recently we’ve witnessed this in the Financials sector in both Canada and the US. Many undervalued bank stocks had traded sideways, some since as far back as 2013, but value investors were rewarded in 2016. In some cases the market took notice gradually throughout the year, while in the US, when low stock valuations in the sector were coupled with the Trump win, Financials saw massive gains in just a few weeks.
It is very common for an undervalued stock to stay that way for a couple of years and rally some 30%+ over a short period of time, making the approach worthwhile.
Most equity investors are also home owners and understand the residential housing market much better. If our house doesn’t go up in value over a period of a couple of years, we don’t lose patience because we recognize that it’s likely a temporary occurrence.
In the equity markets a lack of patience, a lack of understanding and emotional bias are problems for many, and opportunities for others.
Looking for undervalued companies isn’t the only way to make money in the equity markets. Purchasing fairly valued companies with prospects for corporate earnings growth is another approach we favour. We will examine growth style investing at a later date and discuss the benefit of combining these approaches along with others less talked about investment styles.
Have a great weekend!
Daniel Popescu CFP, CIM, FMA, FCSI
President & CEO
MNP Tower, 3100-1021 West Hastings St.
Vancouver, BC V6E 0C3
T: 604-558-6830/1(877) 588-6822
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