Ben Waters, trader, has in-depth knowledge of a variety of different specialisms, including options and delta one trading. This article will look at value investing, an investment style that has largely fallen out of favour over the last decade but can be an effective means of diversification.
Value investing is essentially the process of identifying and investing in stocks that appear to be selling for less than their book value. Markets can overreact to both good and bad news, culminating in significant stock price movements. Often, these movements are based on short-term market sentiment rather than correlating with the company’s long-term fundamentals. Overreactions can create opportunities for profit, enabling savvy value investors – such as Benjamin Waters, trader – to purchase stocks at discounted prices.
Value investing is the remit of broad-minded investors with a long-term outlook. While it is human nature to seek out investment options that are performing well, past performance is not always a reliable indicator of future returns. Where investors follow the crowd into an appealing stock, sector or theme, outsized gains can quickly turn to disappointment where market sentiment starts to run cold.
Investments typically fall into two categories: value and growth. Whereas the goal with value investments is to purchase shares at a discount in terms of their true worth, growth investing focuses on identifying businesses that are capable of achieving above-average growth on earnings and profits. Value investors are naturally contrarian, avoiding meme stocks and fashionable niches, instead seeking unappreciated bargains. Growth investors, on the other hand, care less about the share price and more about the high trajectory of earnings and a business’s long-term worth.
Pitfalls attach to both value and growth investing. Applying a strict value philosophy leaves the investor at risk of falling foul of ‘value traps’, i.e. attaching value to companies that are actually in decline, culminating in poor or negative returns. While growth investments are typically a safer bet, they are usually more expensive. Where the business fails to live up to lofty expectations, this can cost the investor dearly.
Value investing is a strategy largely eschewed by modern investors, bar a brief renaissance in 2022. Compared with growth investing, value investing has typically offered poor returns in recent years. Instead, investors have largely focussed on the ‘Magnificent Seven’ growth stocks and companies renowned for providing consistent returns. However, some analysts speculate that the tide may be changing in line with economic shifts. While growth stocks tend to do better in economic climates with low inflation and interest rates, value stocks tend to cope better with bursts of inflation. In economically sensitive areas such as energy, finance and mining, value stocks can be more resilient where inflation is accompanied by strong economic growth.
In some instances, growth will outperform value. In others, the opposite will prove to be the case. This can be drastically affected by economic headwinds or prevailing investor sentiment. Being solely value-driven leaves the investor at risk of giving up returns from companies that seem expensive but are poised for exceptional growth. High growth investors, on the other hand, can miss out on a significant upside in the form of share price appreciation when unfashionable stocks return to favour.
Recognising market mood and switching back and forth between value and growth stocks in perfect tandem is a virtually impossible task. Recognising this, many experts advocate a ‘best of both’ approach, building and maintaining a diversified portfolio capturing opportunities in all parts of the market. Both value and growth investing can perform well over the long term with carefully crafted and executed investment strategies. Many experts therefore recommend blending both styles to maximize long-term returns. For investors who prefer to adopt a less hands-on approach to selecting value stocks, funds such as Artemis Global Income, Fidelity American Special Situations and Man GLG Undervalued Assets have been created to identify promising stocks hovering in bargain territory.