Should you invest in value stocks now?
A stock is considered to be a value stock when it is trading at valuations lower than its intrinsic value.
The equity market after seeing a vertical rise post-pandemic has witnessed a correction in the last few months. All the major equity indices have declined, however, there are few themes that have performed better than others since the start of the year. ‘Value’ theme is one of them. While Nifty 50 has fallen by almost seven per cent, NIFTY500 VALUE 50 has arrested its fall to one per cent. Nifty 500, its benchmark has fallen by almost nine per cent.
What are Value Stocks?
A stock is considered to be a value stock when it is trading at valuations lower than its intrinsic value. Intrinsic value is a minimum fair value at which the company should be trading ideally after considering current situation and also the future prospects of the company's business, financial condition, and the quality of the management. Participants invest in value stock with a thesis that over long term, the market will understand or recognize the true potential of the stock that would help the stock to trade at least above its intrinsic value. Value stocks provide high margin of safety for the investors as they are already buying stocks trading at a discount valuation.
Different financial ratios are used to identify businesses having relatively low valuation multiples compared to the other companies trading in the market. Ratios like price to earnings, price to sales, price to book value, and dividend yield are mainly used to identify value stocks. Price to earnings talks about the earnings that the company generates for each share of the company. Price to sales ratio helps to calculate how much revenue company generates for each share amount invested into the business. Price to book is used to find out company's net worth relative to its market capitalization. Dividend yield is a measure for company's dividend distribution for each share invested in the company.
Will the outperformance continue
The outperformance of the value stocks has started back from 2021. Since the start of 2021 value theme has been one of the best performing themes. It has generated return of 148 per cent compared to 115 per cent and 119 per cent by Nifty 50 and Nifty 500, respectively.
For many pessimists, this puts a question mark, is it going to perform going ahead? To get a clue to this we first have to understand factors that drives them.
Historically we have seen that value stocks are closely related to benchmark government bond yield movement. Between 2018 and 2019, Government of India, benchmark 10 Year bond yield declined from 7.5 per cent to 6.5 per cent. In the same period NIFTY500 VALUE 50 has declined from 6200 to 3600 a drop of almost 40 per cent.
Relative Movement of 10Y Benchmark Bond Yield and NIFTY500 Value 50 Between 2018 and 2019
Currently, we are witnessing a surge in bond yields. From the lows of 5.91 per cent in the month of December 2020 they have reached to the highs of 7.35 per cent currently. The graph below shows the relative movement in the price of bond yield and Nifty 500 value 50 index a proxy to ‘Value’ theme.
Relative Movement of 10Y Benchmark Bond Yield and NIFTY500 Value 50 Between 2021 and 2022(YTD)
Going forward looking at the inflation trajectory and RBI Governor’s remark of rate hike as a ‘no brainer’, we believe that yield will keep climbing for a while and hence we believe ‘Value’ theme will keep outperforming for a while.
No one can time the markets successfully. Only thing the investor can do is to focus on identifying stocks with strong businesses which are available at cheaper valuations. Value investing strategy has proven track record of outperforming boarder markets over long investment time horizon. The value investing strategy was known to be adopted by the most famous investor of all time, Warren Buffet. The investors who want to adapt Buffet's investment strategy should invest in value stocks.