Value Investing

Value Investing is one of the most popular styles of investing. Nearly all investors will integrate at least a part of Value Investing into their investment approach. The investing style is based on fundamental financial analysis that attempts to determine a company’s intrinsic value and then compares that value to the market price.

An investor’s approach to Value Investing can vary from one investment process to another but generally, if a company’s intrinsic value is greater than the market price, the Value Investor will buy the security with the thesis that forthcoming market participants will catch on to the fact that the stock offers more value than the market currently reflects and the market price will climb towards the intrinsic value. When Value Investing. an investor will consider the intrinsic value as a target price for a stock and will re-evaluate or sell the security once the market price reaches this price.

Value Investing tends to be a longer-term strategy. Value Investors tend to have higher conviction in the stocks that they own, as their theses are based on company-specific financial analysis. Generally, Value Investing portfolio turnover is lower and stock theses take longer to play out when compared to other investing styles.

Value Investing is largely attributed to Benjamin Graham, an English investor and researcher, whose work underpins much of modern financial security analysis. He first wrote a book with David Dodd, titled Security Analysis, after the market crash of 1929. Graham and Dodd established methods used to find intrinsic value by using a company’s factors, such as its assets, earnings, and dividend payouts.

Then in 1949, Graham published The Intelligent Investor: The Definitive Book on Value Investing. This is known by many as the “Value Investing Bible.” It builds upon much of the work done in Security Analysis and specifically defines the advantages and processes involved in Value Investing. One of the quotes from The Intelligent Investor that has become famous within investing circles is:

There are several key metrics that investors focus on when executing Value Investing. These metrics help investors compare valuations, earnings and revenues in a normalized fashion.

Price-to-Earnings Ratio (PE) - This ratio takes the stock price and divides it by the earnings per share, this is a basic valuation metric that shows what the market is willing to pay today for a stock’s earnings.

Price-to-Book Ratio (P/B) - Similar to the PE ratio, this metric shows what investors are willing to pay for a stock’s book value. Book value consists of subtracting the liabilities of a company from its assets, resulting in the book value of its equity. In other words, this metric compares the market value of a company’s equity to the book value of its equity.

Free Cash Flow (FCF) - FCF captures the amount of revenue that is not earmarked for operation and capital expenditures. It is a measurement that shows the efficiency of a company and the company’s ability to engage in dividend payments or share buybacks. FCF tends to be a good predictor of future earnings increases. A company with excess FCF compared to peers is often seen as attractive to Value Investors because there may be a reason to believe that future earnings increases could be a catalyst for the stock’s market value to converge towards intrinsic value.

Price Earnings Growth (PEG) - This modified version of PE ratio takes into account earnings growth. Whereas the PE ratio slowly focuses on a snapshot in time, the PEG ratio can factor in how quickly a company’s earnings is growing (or stagnating or shrinking). Generally, a company with PEG under 1 is perceived as undervalued, but this can vary depending on the market environment and sector.

These are some of the key investment ratios to consider when Value Investing, but we have also provided information on others below.

Core Value - This is the most straightforward version of Value Investing; it focuses on analyzing a stock’s intrinsic value and purchasing the stock if the market value is adequately discounted from the intrinsic value.

Deep Value Investing - Deep value is a more extreme version of Value Investing. This style focuses on stocks of companies with extremely low market prices. In some cases, the companies targeted by Deep Value Investing approaches are subject of market drawdowns due to negative headlines, extreme negative events impacting earnings or fraud. The idea of Deep Value Investing is that the market is overreacting to negative news and the share price provides a reasonable margin of safety. Additionally, when Deep Value Investing, investors might target companies that have become potential acquisition targets because of how low their market valuation has become.

Growth at a Reasonable Price (GARP) - While not technically being a style of value investing, GARP investing integrates pieces of Value Investing into a Growth Investing framework. This style focuses on targeting growing companies but being valuation sensitive when considering an investment. This investing strategy is a good example of how Growth Investing and Value Investing can overlap within an investment approach.

Broadly speaking Value Investing and Growth Investing are two styles at odds with each other. Growth stocks are generally higher priced than the broader markets while lower priced than the broader market. Generally, Growth Investing will prioritize higher earnings growth and be less sensitive to metrics that show that a stock is trading at a higher multiple than its peers. Said another way, investors are happy to pay a premium for higher growth, that others are not willing to pay when Value Investing.

The stock market has gone through different periods where growth or value may outperform. For example, during the recent bull market of 2009-2020, growth significantly outperformed value, as measured by comparing the Russell 1000 Growth Index to the Russell 1000 Value Index. Since 2020, the results have been more mixed and many market forecasters are calling for a more competitive decade for Value Investing.

Value Investing is a very popular style of investing. Even if managers or investors are not strictly using a Value Investing approach, they are likely integrating aspects of Value Investing into their process. Since its early stages with Benjamin Graham, Value Investors have been some of the most noteworthy in the markets. Even considering the leadership of Growth Investing during the 2010s, Value Investing continues to be a very popular style of investing. The Crystal Capital Platform offers the opportunity to create customized portfolios with many managers that have varying levels of Value Investing involved in their investment process, from distressed managers focusing on Deep Value Investing to long short managers that are considering value investments for their long positions and overvalued stocks for their short positions.

Sources:

1. Value Investing Definition, How It Works, Strategies, Risks (investopedia.com)
2. Who Was Benjamin Graham? The Father of Value Investing (investopedia.com)
3. 5 Must-Have Metrics for Value Investors (investopedia.com)
4. Growth vs. Value Investing: Two Approaches to Stock Investing (merrilledge.com)
5. Definition of Core Value Investing (zacks.com)
6. Growth vs. Value Stock Investing: Understanding the Differences - NerdWallet