Now could be the time for value stocks to shine for in­vestors

Sunday Independent (Ireland) - Business & Appointments - - FRONT PAGE - David Flynn

SINCE the global fi­nan­cial cri­sis ended in 2008, growth stocks have sig­nif­i­cantly out­per­formed value stocks. Look­ing fur­ther back, how­ever, we see that value stocks out­per­formed growth stocks for roughly a decade lead­ing up to the end of the global fi­nan­cial cri­sis.

Value stocks are typ­i­cally de­fined as shares that trade at a sig­nif­i­cant dis­count to their true value (some­times known as in­trin­sic value). Value stocks for ex­am­ple may have a low price-earn­ings (PE) ra­tio. (The PE ra­tio is used by in­vestors to get a sense of the value of a com­pany. It is es­sen­tially the ra­tio of a com­pany’s stock price to the com­pany’s earn­ings per share). Value stocks are usu­ally those of ma­ture busi­nesses whose stocks have ex­pe­ri­enced tem­po­rary earn­ings set­backs, or suf­fered due to po­lit­i­cal or eco­nomic events which have hurt their in­dus­try.

Value stocks to­day can be found in emerg­ing mar­kets, Eu­rope, the UK and com­mod­ity stocks.

Growth stocks are shares which are ex­pected to grow at a rate sig­nif­i­cantly above the mar­ket av­er­age. In many cases, growth stocks are the shares of rel­a­tively new com­pa­nies — or of com­pa­nies that have rel­a­tively new prod­ucts.

Some­times growth stocks can also be con­sid­ered to be value stocks, how­ever they of­ten trade at higher prices, mainly be­cause in­vestors pay a pre­mium for growth. Many growth com­pa­nies pay lit­tle or no div­i­dend be­cause they tend to in­vest their prof­its back into their busi­nesses.

Fol­low­ing on from all this, there are three main types of fi­nan­cial dis­ci­plines in in­vest­ing: value, growth and in­come in­vest­ing. In­come in­vest­ing of­ten falls into the value or growth camp. Value in­vest­ing is where in­vestors fo­cus on value stocks. Growth in­vest­ing is where in­vestors fo­cus on growth stocks.

Over the very long term, we know value in­vest­ing out­per­forms growth in­vest­ing. There is much de­bate why that is, but it is prob­a­bly down to some­thing very sim­ple which the late in­vestor Ben Gra­ham taught us many years ago. “Price is what you pay. Value is what you get.”

Val­u­a­tion is a mea­sure of the value or worth of a com­pany. Pay a high val­u­a­tion for some­thing and it takes many more years to get back what you put in. Pay a low val­u­a­tion for some­thing and it takes less time to get back what you put in.

Risk also comes into it. Back­tests go­ing back to the 1800s show us that not only do value stocks out­per­form growth stocks, they also suf­fer sig­nif­i­cantly less down­side. (A back­test is a sys­tem used to test a trad­ing strat­egy).

From a sta­tis­ti­cal stand­point, it is highly un­likely growth in­vest­ing will con­tinue to be the best fi­nan­cial dis­ci­pline for in­vestors over the next 10 years. So now is there­fore prob­a­bly a good time for in­vestors to think how this could af­fect their fi­nan­cial well-be­ing in the fu­ture.

Be­fore the dot­com crash of 2000, tech­nol­ogy stocks were all the rage. At the time, no-one wanted to hear about to­bacco, con­struc­tion or com­mod­ity stocks — all of which turned out to be ex­traor­di­nary in­vest­ments over the long term. War­ren Buf­fet, for ex­am­ple, was buy­ing shares in to­bacco com­pany Philip Mor­ris, a clas­sic value stock at the time. Over the next two years, Philip Mor­ris rose roughly 200pc while the Nas­daq 100 Tech­nol­ogy in­dex dropped roughly 80pc.

Each eco­nomic cy­cle is dif­fer­ent so I’m not nec­es­sar­ily ad­vo­cat­ing to­bacco, con­struc­tion or com­mod­ity stocks now — but Buf­fet’s in­vest­ment in Philip Mor­ris back then is a great ex­am­ple which should not be for­got­ten. David Flynn is chief in­vest­ment strate­gist with Bag­got In­vest­ment Part­ners ([email protected]­ Any in­vest­ment com­men­tary in this col­umn is from the au­thor di­rectly and should not be seen as a rec­om­men­da­tion from The Sun­day In­de­pen­dent

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