Value investing is a lonely business and the best opportunities may come with suffering

While I was walking the dog on Sunday, a gentleman recognised me and asked what my next column was about. I said I would look at the mindset of value investing.

He was a supporter of this approach but pointed out how some value funds simply refuse to turn, no matter what, and languish at rock bottom for way beyond the normal long-term investment horizon.

In theory at least, value investing is a simple concept. Perform your analysis; discover shares that appear to be undervalued; and hold them until they become fully valued. In practice, it is often much more difficult, as the general market direction often confounds the cleverest of analysts.

Value investing requires decisions that take time to come to fruition. Portfolio managers must demonstrate great resilience in the face of severe criticism, defending their strong conviction on sectors and/or companies they believe they have bought at seemingly good value, and continue to hold through continuing or even worsening bad times. And then the share goes way up, often with no apparent catalyst for this change.

PSG Asset Management (PSGAM) chief investment officer Greg Hopkins summed up this approach at PSGAM’s Outlook 2020 presentation to investment advisers: “You buy shares when they are cheap, as quality goes on sale when there is distress. Then they become extraordinarily cheap. You suffer; you double down, which is very difficult to do in practice; you suffer a bit more. And then you win. The best opportunities are often associated with suffering.”

Actions are contrarian, buying in times of panic and selling when the mood is euphoric. Hopkins cites Capitec Bank as a good example of the PSGAM approach. Back in 2013 and 2014, African Bank was imploding. The investing herd intuitively looked around for the next second-tier banking disaster, concluding it might be Capitec. It got tarred with the same brush as African Bank, even though it was a very different type of operation, and the share was sold down relentlessly.

Admittedly, the macro environment in which Capitec was then operating was poor, but PSGAM’s exhaustive research pointed to it having a good micro position, and it therefore bought the share. At that time, its share price was about R180, on the same priceearnings (PE) ratio as the broad banking sector. The market was not assigning any premium to the Capitec share price and was ignoring its growth prospects.

It would have been all too easy to go with the populist view and ignore Capitec. However, Capitec now trades at more than twice the banking sector PE, at a share price of R1,375. Brave investors have ridden the wave upwards and sit on a handsome profit.

Hopkins applies the same philosophy to road construction company Raubex. The sector remains under severe stress, and Raubex has issued two profit warnings, due mainly to Sanral not awarding tenders for new roadworks.

But its intrinsics are good, with 37 years of uninterrupted growth, the founder is still involved, and management think and act like owners. While

PSG believes it is above-average quality, the suffering period may be quite protracted.

This strategy will undoubtedly post a few mistakes along the way. Hopkins paraphrases Warren Buffett, who calls these “unforced errors”. He is also not concerned with portfolios still in the “suffering phase” as many SA shares are sitting on very low PE ratios and high dividend yields as the local equity market languishes. Value investors are used to being patient and taking strain if they believe it is justified in the longer term.

But what do you say to those investors who have been waiting over five years — or even more — for a value fund to perform? If they are receiving a good dividend in the meantime, the pain is lessened, but if not, it is major pain for them.

Unfortunately, many of the value managers who do not deliver slink away into anonymity, even get hired elsewhere, unaccountable to their investors. Who is suffering then?

AFRICAN BANK WAS IMPLODING. THE INVESTING HERD INTUITIVELY LOOKED AROUND FOR THE NEXT SECOND-TIER BANKING DISASTER

VALUE INVESTORS ARE USED TO BEING PATIENT AND TAKING STRAIN IF THEY BELIEVE IT IS JUSTIFIED IN THE LONGER TERM