ONE of the most lucrative strategies in the investment book is value investing, or investing in firms that appear undervalued when analysed using a certain type of fundamental analysis. For example, if a company’s share prices is lower than its dividend yield, or its book value. Famous proponents of this strategy include Warren Buffett, and for those with the stomach to take long positions in companies that have been ignored by the market, then the rewards can be big. And this is just the moment in the economic cycle to start sniffing around.
There are signs that value investing is back in vogue, which is ideal for medium to long-term contracts for difference (CFD) traders. Goldman Sachs, the US investment bank, thinks so. It argues that the economy has now moved into a growth phase, which typically means that value stocks will outperform the more popular growth stocks.
Goldman analysts point out that during the growth period markets are driven by earnings, which bodes well for value stocks since they tend to have stronger balance sheets and better earnings potential than growth stocks.
George Godber, fund manager at Matterley, an investment management firm that specialises in value investing, agrees. “In an uncertain economic environment, value strategies tend to come back into focus, since they give you something to hang your hat on,” he says.
There’s more to a value strategy than just buying a stock because it’s cheap. The job of the value investor is to hunt through company balance sheets and find companies that are both good value and have strong economic fundamentals, such as low debt levels.
So where is he looking now? The financial, industrial and consumer discretionary sector, he says. Godber also likes the outlook for drugs giant GlaxoSmithKline, “because of its growing sales in emerging markets and strong cash flows.” He is also attracted to the boutique hotel chain Millennium and Copthorne. Although the company has seen its earnings collapse during the economic downturn, it has a strong balance sheet to weather the storm: “The company owns all of its hotel buildings and it’s trading below its net asset value,” says Godber, whose fund has long positions in both of these stocks.
Godber gives three tips for a novice value investor. Firstly, look for companies with low levels of debt: “This investment strategy can take a while to be realised, so choose companies that have robust capital structures, with high levels of cash and low levels of debt, so they can more easily withstand any economic slowdown.”
Secondly, look at whether a company is cyclically or structurally out of favour with the market. If it is cyclical then the company is a candidate for resurgence. “Engineering stocks should perform strongly after the recession,” Godber says.
His last point is that value investors shouldn’t get involved with companies they don’t understand: “You need to know the company’s balance sheet to recognise if there is value there, if you don’t understand the business model then stay away.”
If you are keen to pursue a value strategy then it’s worth cracking a company’s balance sheet. Now is the time to get ahead of the pack.