Value investors: why are they so calm in a crisis?
As the impact of coronavirus and the resulting response by global policymakers becomes clearer, the stock market will continue to react. Share prices will move up and down reflecting the perceived winners and losers of this developing situation. However, the “true” value of businesses typically changes very slowly over time.
Many experienced market participants who take a long-term view say events such as the coronavirus outbreak should not impact the way investors think about stocks. Investors should not, they caution, buy or sell businesses based on news headlines.
Value investing involves taking a long-term view. Here are some answers to questions about value investing and how it performs in challenging markets.
How do investors work out a company’s true value?
This involves ascertaining the true value of companies based on their “fundamentals”, such as their profit-generating potential, and financial, or balance sheet strength. It involves buying companies whose shares are trading below their true value, so attractively valued, and selling them when they are trading above their true value.
Such investors believe stock markets tend to overreact to both good and bad news, thereby allowing them to take advantage of resulting price distortions. This approach is called value investing.
Does value investing offer an attractive proposition in challenging markets?
Value stocks are often businesses that, having had one near-death experience, are doing their utmost to avoid having another. Such companies tend to be prudently managed, with solid balance sheets and are therefore potentially prepared to weather what the future has in store, although each situation needs to be analysed on a case by case basis.
But haven't many value stocks underperformed as markets have sold-off?
It’s true that the market reaction has been to sell value stocks in the commodity and financial sectors. This is perhaps unsurprising given fears around the impact of coronavirus on the global economy as these are economically sensitive areas of the market.
However, these companies have some of the strongest balance sheets in the world today, which, when coupled with their attractive valuations, and a rigorous selection process, makes some of them worth considering for those willing to take a long-term view.
The detailed work involved in ascertaining a company’s true value and testing its fundamentals in a wide range of possible future economic scenarios may not be a “virus outbreak test”. However, it is a severe financial stress test, akin to the conditions that businesses endured through the 2008/09 global financial crisis.
Will value investors be maintaining their same approach amid current events?
Yes, they will continue to spend the vast majority of their time poring over company reports and accounts to answer the question: “Is the balance sheet good enough?” This is because arrangements that appear sustainable in today’s benign environment are often onerous in more difficult times.
They will remain focused on ascertaining the true value of companies and unafraid to buy when others are fearful, in line with their long-term approach.
Kevin Murphy, Fund Manager, Equity Value, says: “We don’t know where share prices will settle over the coming months. No one does. However, we will act as we always do, going wherever the value is in the market. Buying things that others find uncomfortable, and often buying things that others currently believe are tainted. As those negative perceptions and issues alleviate, share prices rebound.”
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
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