Why value investing transcends the economic cycle
Value is not all about interest rates or inflation, it is about hunting for cheap businesses – wherever they happen to be – in order to build a diverse portfolio of stocks with different drivers and exposures
Navigating seas as uncertain as those to be found in the world of investment, it is entirely understandable that people should seek out reference points to help them plot a surer course. Here aboard HMS Value Perspective, for example, the crew often highlight a single chart that shows why a value-strategy approach to investing works and is, in essence, the North Star for our own voyage.
Of course, some navigational methods have stood the test of time better than others and, in the hope of staying afloat, investors can find themselves turning to practices that, in reality, risk them running aground. Take, for example, the conventional wisdom that investors should buy – and avoid – only certain types of investment at certain times as the economic cycle progresses through expansion, peak, contraction, trough, repeat ...
From there, conventional wisdom continues, the best time to buy value stocks, for example, is after a recession or other crisis – the so-called ‘reflation trade’ you may well have seen referenced as countries looked to stimulate their economies as they emerged from lockdown. And by the same token, if the world is heading for a huge recession – as some market-watchers now believe – the last place you want to be is value.
Such thinking may contain a reassuring element of simplicity – indeed, that is arguably the quality that makes conventional wisdom so, well, conventional – but is it correct? Here on The Value Perspective, we would argue the reality is rather more nuanced and the opportunity set available to global value investors is a great deal more diverse and varied than is generally appreciated.
The value you might expect
Before enlarging on that, we should quickly add this does not mean we are not finding some very undervalued businesses in the more cyclical areas of the market that are seen as value’s traditional stamping grounds – for instance, banks trading at large discounts to their book price; or energy companies that, while the focus of justifiable concerns over structural threats, are returning material amounts of cash to shareholders.
A third example would be car manufacturing, where the market seems to be extrapolating a cyclical trough in production out into perpetuity – and yet, contrary to popular perception, value investors are not solely focused on such sectors. While we definitely have exposure to these, if you like, ‘value poster-children’ – for example, they make-up around a third of our global recovery portfolio – our thinking is not dominated by them.
For one thing, we also own a large number of businesses we view as high-quality franchises with high return on capital – but where the wider market has just fallen out of love with them. Often these will be in more ‘defensive’ sectors, such as pharmaceutical giants where investors have become very downbeat on pipeline delivery; or brewers that are struggling in the aftermath of the declining volumes seen during the pandemic.
Another example would be once-loved technology giants that are now facing competitive pressures – but the key point here is that there are always a wide variety of different businesses in different sectors that will become cheap for different reasons. It follows, therefore, that it is not all about the economic cycle – it is about being open to identifying the idiosyncratic opportunities wherever they happen to crop up.
Hidden in plain sight
Speaking of such opportunities, no region better encapsulates the way value stocks can come in all shapes and sizes than Japan. Here investors can find some incredibly cheap businesses – often with hidden assets to which the wider market appears blind. When we first looked at one Japanese media giant, for example, its net cash and bond investments were worth more than the company’s entire market capitalisation!
In effect, then, the market was paying you to buy the core operating business – and that operating business is none too shabby either: it is one of Japan’s leading broadcasters by market share; it is highly cash-generative; and it even includes one of Japan’s leading online streaming platforms. That, we would argue, represents a pretty remarkable example of market inefficiency.
A similar example would be the Japanese mobile gaming business that owns a stake in Nintendo that, by itself, is worth a very large portion of its market capitalisation. And then there is the company that most investors would casually dismiss as a structurally dying camera franchise. Look under the lens-cap, however, and you will find a very attractive lithography tools business.
In our analysis, that alone is worth far more than the company’s current market value – yet, on top of that, there are other nascent businesses, in areas such as healthcare technology and 3D printing, where it has also been investing. For these reasons and more, we see Japan very much as a forgotten market and one where patient value investors with an eye on the fundamentals can unearth some very attractive bargains today.
Beyond that, here on The Value Perspective, we believe there are plenty of opportunities in a whole host of businesses that are undergoing operational turnarounds – for example, the global retail pharmacy giant that is in the process of unwinding years of ill-though-out regional expansion in order to refocus on its core US health operations.
Or the luxury department store chain and the money transfer multinational, both based in the US and both in the process of effecting major structural shifts from traditional retail transactions towards digital-first, online business models. Or the US-based energy giant that is working to transform itself from a coal and gas-powered utility into a much cleaner power generator over the course of the next decade ...
Challenge brings opportunity
Wherever there are major changes happening, there are challenges – and wherever there are challenges, there are likely to be opportunities for value-oriented investors who are willing to swim against the tide of market sentiment in order to find the unloved and the misunderstood bargains that tend to find themselves left behind as a result.
As this whistle-stop tour of the wide world of value illustrates, value comes in all shapes and sizes, which is why, here on The Value Perspective, we do not consider the strategy to be a one-dimensional macroeconomic bet. Value is not all about interest rates or inflation, it is about hunting for cheap businesses – wherever they happen to reside – with the aim of building a diverse portfolio of stocks with different drivers and exposures.
I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014, I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm and hold a Economics and Politics degree.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German, Tom Biddle and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
This article is intended to be for information purposes only and it is not intended as promotional material in any respect. Reliance should not be placed on the views and information on the website when taking individual investment and/or strategic decisions. Nothing in this article should be construed as advice. The sectors/securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy/sell.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.