InCred Wealth, September 04, 2024
Types of Investment Strategies - #1 Value Investing
Navigating the complexities of financial markets can be daunting, even for the most seasoned investors. The constant ebb and flow, the hype, and the intricate details can seem overwhelming. However, the potential for substantial wealth accumulation is too significant to ignore.
With so many fund managers and fund management styles to pick from, we have created this series of blogs to help you understand the various types of investment strategies out there. In our first blog, we covered the various types of investment strategies and we will now cover each one in-depth beginning with “Value Investing”.
Understanding the Fundamentals of Value Investing
What if there was a strategy that cuts through the noise and focused on true value?
“Value investing is nothing but buying an outstanding company at a sensible price!” - Warren Buffet
This explanation by the legendary investor Warren Buffet encapsulates the real essence of Value investing. But let’s explore further -
Value investing is the practice of buying stocks or securities that are priced lower than their true worth, with the expectation that their value will be recognized by the market over time.
It is based on the principle of buying securities that are undervalued by the market.
The core idea is to identify stocks trading below their intrinsic value, which provides a margin of safety for the investor.
Learning the Core Principles and Key Terminology
The world of finance is intricate, full of jargon, and constantly evolving, which can make it seem quite overwhelming.
Let’s simplify the primary components of value investing:
• Intrinsic value is the true worth of a company based on its fundamentals.
For example, a diamond worth ₹1,500, but being sold for ₹500 has an intrinsic value of ₹1,500. Similarly, investors aim to discover stocks that are undervalued in the market, offering great potential for profit.
• Undervalued stocks are those priced lower than their true value.
For example, a stock trading at ₹20 but having a true value of ₹30 is undervalued by ₹10.
• Margin of safety is the difference between a stock's market price and its intrinsic value, providing a buffer
For example, a stock worth ₹50 but priced at ₹30 has a ₹20 margin of safety.
Putting it all together-
Value investing involves buying undervalued stocks with a margin of safety, expecting the market to correct their prices over time.
This strategy aims to make exponential returns from these corrections.
Streamlining Wealth Management with Value Investing
“Value investing strategies tend to outperform other Investment Strategies during periods of rising interest rates and inflation.”
Benefits of value investing:
• Stability and Long-term Growth
For UHNIs, Value investing offers a stable and conservative approach for growing wealth.
Focusing on companies with solid fundamentals and trading below their intrinsic value, can help investors achieve steady, long-term growth, without much hassle and risk.
• Preservation of Wealth
Value investing emphasizes a margin of safety, helping UHNIs preserve wealth by minimizing downside risk and protecting capital through investments in undervalued, fundamentally strong companies. This approach ensures long-term stability and mitigates overvaluation risks, offering psychological comfort during market volatility.
• Opportunities for Significant Returns
Despite its conservative nature, value investing can provide significant returns.
As mentioned above, the key consideration of value investing is to ensure buying undervalued stocks, or the stocks which have a lot of unrealised value, which whenever realized leads to significant returns and a greater risk to reward ratio.
• Diversification Benefits
Value investing allows UHNIs to diversify their portfolios across various sectors and industries, as it requires minimal efforts and rebalancing.
In the world of finance, diversification has been a well known savior which reduces risk and provides exposure to different growth opportunities.
Now that we understand what value investing is and how it can be beneficial for Wealth Accumulation and Management, let’s explore the risk involved in value investing!
Identifying and Mitigating Risks Involved in Value Investing
Value investing can be a powerful tool for wealth creation, but like any investment strategy, it comes with its own set of risks. While all investments come with associated risks, as an investor one must remember that the risks are best managed by professional fund and portfolio managers, who have an investment team at their disposal to do in-depth research and analysis.
Here are some common pitfalls to watch out for:
• Value Traps:
Some stocks that appear cheap are fundamentally flawed and unlikely to recover, yet they lure investors but often fail to deliver long-term gains.
• Market Timing:
Trying to predict market movements is the worst way to waste your energy and takes away the advantages of investment. Even the most undervalued stocks can take time to realize their potential.
• Economic Cycles:
Value stocks can be particularly vulnerable during economic downturns or industry-specific slumps. Some basic understanding of economic and business cycles and its phases can help you understand the reasons behind the stock being undervalued and might also help in mitigating these risks.
• Management Missteps:
Companies often deteriorate their value proposition with poor corporate governance or bad management decisions, which significantly impact the performance of value stocks.
Strategies to Mitigate These Risks:
• Conducting Thorough Fundamental Analysis
Assess a company's financial health and performance to make informed investment decisions. Look for signs of strong cash flow, manageable debt levels, and consistent earnings growth. Evaluate the cash conversion cycle and interest coverage ratio for ensuring financial stability.
• Ensuring a Margin of Safety in Investments
Buying stocks at a significant discount to their intrinsic value to protect against market volatility and errors in analysis. Use analysis to estimate intrinsic value and aim to purchase stocks well below this value with a margin of safety. A margin of safety provides a buffer against unforeseen market downturns, enhancing investment security.
• Diversifying Across Sectors and Industries
Avoid putting all your eggs in one basket! Diversify your investments across various sectors and industries to reduce risk exposure. Diversifying investments across different sectors reduces the impact of a downturn in any single industry. Allocate investments across various sectors like technology, healthcare, and finance to spread risk.
• Staying Updated about the latest happenings
It’s no brainer! Keeping abreast of macroeconomic and microeconomic factors to anticipate market risks and opportunities. Regularly follow news on government policies, trade agreements, market demand, and other economic indicators. Staying informed helps make proactive investment decisions, reducing exposure to unexpected market changes.
Successfully navigating the risks of value investing requires not only knowledge and vigilance but also the wisdom of experience. These challenges can feel overwhelming, which is why learning from the best in the business is so valuable.
Famous Fund Managers known for Value Investing
Let's have a look at a few of the most famous fund managers who are known for their Value style of investing:
• Sankaran Naren,
Executive Director and Chief Investment Officer at ICICI Prudential Mutual Fund
Sankaran Naren is widely known for his contrarian approach to value investing, emphasizing patience and long-term growth.
With over three decades of experience, he has consistently steered funds through volatile markets, advocating for disciplined investing during market extremes. Naren's belief in cyclical value plays led to strong performance in sectors that others had overlooked. One of his most significant achievements was his successful navigation of the 2008 financial crisis, turning challenges into opportunities.
His philosophy underscores the importance of staying calm and following a well-researched investment strategy during turbulent times.
• Prashant Jain,
Chief Investment Officer at HDFC Mutual Fund
Prashant Jain is a stalwart of Indian value investing, known for his deep conviction in the long-term potential of undervalued assets.
With a career spanning over 25 years, Jain has an exceptional track record, focusing on fundamental analysis and margin of safety in his stock picks. He believes in investing in quality businesses at reasonable prices and holding them for the long term, regardless of short-term market noise. His leadership at HDFC Mutual Fund has made it one of the largest and most trusted mutual funds in India.
Jain's disciplined approach and stellar performance through multiple market cycles stand as a testament to his value investing acumen.
• Chokalingam Narayanan,
Fund Manager, ICICI Prudential Mutual Fund
Chokalingam Narayanan brings a deep understanding of cyclical sectors and emphasizes the importance of earnings growth in his value investing strategy.
His focus has often been on sectors that are out of favor, finding value where the market sees risk. By identifying companies with strong fundamentals yet temporarily suppressed valuations, he creates portfolios that thrive in recovery phases. A notable achievement was his timely entry into the infrastructure and industrial sectors, resulting in significant returns for his investors.
Narayanan’s approach highlights the importance of timing and industry expertise in value investing.
• Sameer Rachh,
Fund Manager, Nippon India
Sameer Rachh is recognized for his focused and meticulous approach to value investing, primarily targeting companies with solid financials that are trading at attractive valuations.
His focus on in-depth research and a bottom-up stock-picking strategy has enabled him to consistently deliver strong performance across market cycles. By identifying mispriced opportunities and holding investments for the long haul, Rachh has carved out a reputation for disciplined and insightful investing. One of his major successes includes his investments in the pharmaceutical sector, which paid off handsomely during challenging market conditions.
His work emphasizes the power of research-driven, patient investing.
• Manish Gunwani,
Head - Equities, Bandhan AMC
Manish Gunwani is known for blending value investing principles with growth opportunities, creating a balanced portfolio that can perform across market environments.
With a keen eye for macro trends, he focuses on identifying companies that can sustain growth while being undervalued. His leadership at Bandhan AMC has been marked by a mix of value and growth plays, allowing the fund to outperform peers in both rising and falling markets. Gunwani's achievement in maintaining fund stability during periods of market turbulence highlights his ability to adapt value investing principles to changing conditions.
His approach reinforces the idea that value can be found in growth if approached with a discerning eye.
These legendary fund managers have exemplified the power of value investing, showing us that disciplined, and research-driven strategies can yield remarkable results over time. But while their stories inspire, the nuances of applying value investing principles to your own portfolio can be complex and highly individualized.
Though we’ve packed this guide with as much actionable advice as possible, remember, this is just the tip of the iceberg. The world of value investing is vast and intricate, and we can't overlook the significant risks involved in financial markets.
That's where personalized guidance comes in. Imagine having a trusted financial advisor by your side, someone who specializes in long-term investment strategies. They can help you navigate the complex market dynamics and ensure your portfolio aligns perfectly with your financial goals.
If you’re excited about exploring value investing opportunities, we would be absolutely delighted to assist you on your investment journey!
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