Especially in difficult times, where it is when it tests one’s commitment to one’s principles and methods.
Value investing is one approach where one simply buys the companies that are available at significant discounts based on their intrinsic value. Benjamin Graham developed the concept of value investing in the early 20th century.
Together with David Dodd, he co-authored a book called “Security Analysis” in which they discussed various value-added investment methods.
By buying stocks that appear to be undervalued, value investors could bet that these companies would be rediscovered by other investors and then profit from the resulting price correction. In other words, buying low and selling high is the principle of value investing, which may sound simple but difficult to implement.
Although it is possible to calculate “value” quantitatively, it is quite subjective due to the many assumptions that go into it.
Value investors usually use a company’s past performance as well as its forecasted future performance to determine its current value as well as future value.
Value investing is conceptually good; no one can claim that it is wrong to buy with a “safety margin”. However, when you limit yourself only to the companies that are available at a discount, you could miss out on good companies that are growing rapidly and attract a lot of investors.
The reasons could be that they are leading innovations in the field of technology (eg:
in India) or are expanding rapidly into new markets (eg: D-Mart, which is yet to grow for a long time).
Some of these companies are also run by highly qualified executives with great honesty that gives the investor comfort. While these companies may seem expensive, their stock prices could rise for several years; a value investor could miss out on such a return.
Sticking to value investments at all costs (actually at “low prices”) could lead to companies that have low value-to-income multiples, but unfortunately for good reasons.
This is called a “value trap” because the investor is stuck with a certain valuation and could miss the big picture.
This is where a “quality approach” to investing helps. One way to build a quality portfolio is by choosing a company with strong ROOTS (a debt-free company with consistently high return on equity and owned by a coordinated project manager) and WINGS (a company with growing sales, operating income and cash flow).
Using this measure, one realizes that some sectors, such as utilities, airlines and telecommunications companies, may be inefficient. Consumer goods, manufacturing, e-commerce, technology, financial services and pharmaceutical companies are examples of economically viable and consumer-oriented industries that often have strong roots and strong wings.
Quality portfolios can often seem expensive compared to value portfolios. This is because the focus is not just on the price but on the overall health of the company and its demonstrated ability to scale.
Our experience with high-quality portfolios using ROOTS & WINGS is that every 3 years they have beaten the Nifty50 standard consistently, both in back tests and in live results since it was launched.
When we removed companies with the highest PE ratios, ie. over the limit of 90% PE in its sector, we found that the long-term success of the policy decreased. This result was not very variable by lowering or increasing the cut.
Another interesting figure to consider is the Nifty Midcap 150 Quality 50 index has been better than the Nifty Midcap 150 index over the past ten years.
This quality index is selected by companies based on return on equity, financial indebtedness and interest per share (EPS) over the last five financial years.
A quality approach equals both the growth (WINGS) and the structure (ROOTS) of a company. In this way, it reduces the risk of other investment methods such as interest rates; the latter may seem attractive in beef markets, but could see a major correction when bear markets follow, as evidenced by the sharp downturn in the field and technology companies: there are examples of
in India and Netflix, Freshworks, etc. in the United States.
To sum up, a quality approach tends to perform better than value plans or growth plans over time, because they can choose the best companies that are able to increase long-term profits.
(Disclaimer: The equities mentioned in the article above may be part of our recommendations at some point. Investors should consult with an SEBI-listed investment advisor before investing in equities. The advice, tips, opinions and opinions of the experts are their own. This does not reflect the views of the Economic Times.)
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