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The stock market has been volatile for most of this year, with periods of correction and significant up-moves. Despite being almost flat this year, the market is still up 45 per cent since September 2013. At a one-year trailing price-to-earnings multiple (PE) of 22.2, the Sensex is still trading above its historical average.
For value investors, this could be a tricky period. Should they use the intermittent corrections as buying opportunities? Or stay on the sidelines, owing to high valuations?
Experts believe there are still enough opportunities to 'value pick' in this market. "I would look to identify companies that are in strong businesses and which offer good growth potential over a period of time, available at discounted valuations. For example, one could look at Indian private banks, though selectively," says Venugopal Manghat, co-head of equities, L&T Investment Management.
According to S Naren, chief investment officer, ICICI Prudential MF, investors can scout for value in companies which underperformed from 2007 to 2015. "Since these stocks have offered modest returns over the eight-year period, investors have shunned these for want of attractive returns. We believe a robust bottom-up picking approach for these stocks can offer value opportunities," he says.
Manghat feels investors would be better off adopting a stock-specific approach, instead of looking at sectors to identify value. "Broadly speaking, I would think one is more likely to find value in the cyclical sectors than in defensive consumption sectors at this point. Cyclical bets could offer value as these could be companies at cyclically low earnings, with good potential to grow as the cycle turns," he says.
Large-caps vs mid-caps
There has been a broad-based rally during the past year, in which mid-caps and small-caps ran up substantially. Is there still value left in these?
According to Naren, large-caps appear reasonably valued, including some in the pharmaceutical and consumer space which have corrected significantly. "In the mid-cap and small-cap space, some stocks are trading at 40-50 times the PE. They might correct but at this point, large-caps are relatively attractive. Investors should choose either large-cap funds or balanced funds, with an aim to avoid any downside in the short term," he says.
Nilesh Shah, managing director of Kotak MF, says the chances of finding value in small-caps and mid-caps are theoretically much higher. For, there are at least 5,000 such listed stocks available, which are far less researched than large-caps. Having said that, he feels that there are pockets of value in the latter as well. "Many large companies have cut costs and, at the same time, invested significantly in building capacities, brands, distribution and innovation during the last downturn. These could offer good value-buying opportunities for investors," he says.
Value traps
Buying into unreasonably cheap stocks might, however, also end as a value trap for investors. "Currently, we see value in select metal stocks. However, some of these could be value traps because the value of their debt might ensure these companies do not have sufficient intrinsic value. Also, some of the highly leveraged infrastructure companies seem to be value traps at this point," says Naren. He adds one way to avoid value traps is to avoid unreasonably cheap, low PE or low price to book companies.
Experts say once a value stock has been identified, it is imperative to note the potential catalysts that can help monetise value of the assets into earnings in a reasonable time frame. "A number of stocks might optically look cheap but really have no inherent strengths or factors to re-rate. These could be value traps," says Manghat. "Also, stocks can de-rate to abysmal levels for reasons like corporate governance issues or misallocation of capital, deterioration of balance sheet or return ratios because of the structural decline in the business. These are traps one should avoid."
Strategy
The best time to go hunting for value picks is during a negative global event. In the past decade, for instance, there were two such major opportunities - the September 2001 ('9/11') attack on the World Trade Center in New York and the Lehman crises. After both, stocks across the world went into a free fall. "When you have big global events, markets become cheaper, which provides investors the biggest opportunity for absolute value," says Naren. The other good time to collect value stocks is when business leaders or businesses with limited competition fall to low valuations, say experts.
According to Shah, it is important to build a portfolio of value investments, rather than having a concentrated holding, so that different catalysts play out at different points in time.
Naren believes investors should be agnostic on market-caps while searching for value picks. "Given the way the markets have got integrated, value can be unlocked in large-caps as well as mid-caps or small-caps. Therefore, flexibility across market capitalisations could be a suitable style in value investing," he says.
Experts believe one must avoid the temptation to exit value stocks too quickly, especially in a rising market. "Identifying good value opportunities is difficult in a runaway bull market, as stocks move from value to expensive in no time. Even if you have identified a long-term winner, as valuations move up and the stock gets re-rated, there is the dilemma of having to switch to a more attractive value proposition, which might not be the best thing to do," says Manghat. Naren believes in the case of mid-cap stocks, it is better to sell slowly rather than deciding the peak price.
| Use volatility to identify bargains |
Mark Mobius |
Value investors tend to invest in stocks when things are looking bad, so that they are able to invest cheaply and then wait for the market to realise the true value. In general, these investors tend to avoid paying unreasonable prices for stocks.
It can be successful in all types of markets, including high-growth ones such as India and China. It is not the type of market that dictates its success but factors such as but not limited to market sentiment, lack of knowledge/understanding, and business life cycles which leads investors to buy stocks with weak fundamentals or sell stocks with strong fundamentals.
Emerging markets have traditionally been volatile and can be dominated by retail investor flows and sentiment changes but we seek to use this volatility to identify potential bargains. We believe strong growth prospects in many emerging markets aren't always recognised in equity valuations and can lag those of developed markets by a considerable margin.
As such, select companies or sectors in our portfolios might not perform as we'd like in a given month or year, but we are long-term investors, not short-term traders and we abide by our sell discipline.
We think the best indicator of whether a stock is a good value or has lost its lustre (what one might call 'a value trap') or fallen but still expensive relative to its intrinsic value boils down to growth. If we don't see any growth potential, a company isn't worth investing in; but if it's inexpensive and earnings projections look good there can be a case to invest. Of course, when a particular stock market is rapidly rising, it can be harder to find individual values.
If a stock approaches what we deem to be fair value, we could consider reducing a position.
Excerpts from an email interview with Ashley Coutinho
