Perspective

Value investing is neglected, not broken


Value investing’s underperformance over the past decade has inevitably prompted concerns that value has experienced an existential crisis. However, outside the industries directly impacted by the global pandemic, the widespread de-rating of many out-of-favour stocks during 2020 does not seem justified and we fully expect it to be reversed in due course.

Best returns usually come from cheap, high quality stocks

It is not unusual to pay a premium at times for higher quality or faster growing companies. Over the longer term though, the best returns have been generated by cheap and higher quality companies.

We define a value (cheap) company based on multiple metrics, including earnings, cashflows, and quality adjusted dividend yield. Quality is a composite of profitability, stability, financial strength, expected growth and superior governance.

Since 2017, cheap and high-quality companies have been left behind, while the best performing stocks have almost exclusively been at the expensive end of the spectrum. The increasingly disruptive nature of technological change has clearly been a key driver of market performance with a “fear of missing out” mentality benefitting a handful of well-known stocks. But how long can this last?

Are cheaper companies structurally impaired?

The strongest argument against the return of value is that the business models of cheaper companies are structurally impaired, thereby justifying their deep discount. We would agree that it definitely pays to be selective in order to weed out the stocks that are “cheap for a reason”, hence the strong integration of quality in our investment process.

However, outside the longer-term losers from the pandemic and sectors facing cyclical headwinds, such as banks and energy companies, we find little evidence that the earnings’ prospects of cheaper companies have deteriorated.

We argue that the neglect of value is the other side of the market’s fixation on a small group of winning stocks, rather than any structural impairment in value stocks themselves. This has led to low market breadth and a level of index concentration not observed in several decades.

At present, the broad-based neglect of value means that there are now plenty of high quality but very affordable opportunities across most sectors and regions. These include many traditionally defensive areas such as telecoms, health care and some consumer staples.

Conclusion

The strongest argument for why value tends to outperform growth over the long run is that investors ultimately overpay for growth. This seems even more true today. However, there is a growing consensus that a sustained market rotation is on the horizon following the recent good news on Covid-19 vaccines. We believe that this rotation will lead to a broadening in market participation away from the expensive mega-cap stocks as investors realise the neglected value in high quality companies, setting them up for a long-overdue re-rating.

We continue to caution that successfully investing in value depends greatly on effective implementation and good stock selection. A focus on quality is critical. We believe that a diversified all-cap approach, while avoiding the areas of low-quality value, will be key going forward.

Important Information
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
This material, including the website, has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.