Wealth-Forum e-zine

Speaking at the launch, Ashu Suyash, Managing Director and Country Head - India, Fidelity International, said, “With the launch of the Fidelity India Value Fund, we are broadening our offering of equity funds. Value investing has at its heart a bottom-up stock picking approach given its focus on finding undervalued stocks. This plays perfectly to Fidelity’s investment philosophy of bottom-up stock picking focused on the core strengths of a company based on first-hand, 360-degree research.”

Nitin Bajaj, Fund Manager, Fidelity India Value Fund, said, “Value investing has a real role to play even in a growth economy. The fact is that there is little or no correlation between whether a stock is undervalued and the GDP growth of that economy. If you look at the last ten years, in which India saw strong GDP growth, you would still find that value outperformed growth by two times

“As long as markets are driven by sentiment and emotions like fear and greed, we will see market inefficiencies and momentum which will give rise to valuation anomalies. It is these undervalued stocks that I’m looking to uncover,” said Mr. Bajaj.

nitin

What is value investing : where to look for value?

Equity markets, from time to time, present situations which are called “Valuation Anomalies”, in which the market either overlooks or is ignorant of the value – either hidden or emerging out of a shift in business parameters. Value Investors wait for these situations to identify suitable investment opportunities.

There are basically three kinds of valuation anomalies that can be seen in the markets:

Over-pessimism – the entire market becomes pessimistic about something and the stocks start falling. Because the stocks are falling, no one wants to invest in them.

Under-estimated structural earnings potential – this structural change happens in an industry or a business which changes it from a fundamentally bad to a good business. And because the markets are so taken by what is happening currently, they miss the structural change.

Under-estimated change (the extent or pace) – this arises where the extent or pace of change is not properly estimated by the market.

The key point of note here is that market will always present such valuation anomalies. These anomalies in turn, are driven by risk-aversion of market players who would like to stay with the crowd and invest in stocks which are already going up no matter how expensive they are. Markets are going to be driven by greed and fear and this is what will create valuation anomalies.

Value investing vs growth investing : which works better?

Fidelity’s data suggests that the value investing style seems to have outperformed growth investing not just in mature markets, but also in emerging markets including India as well :

Value vs Growth : Global context

Value vs Growth : Emerging Markets

Value vs Growth : Indian market

Valuation focussed approach vs momentum based approach : which delivers better long term returns?

Fidelity’s research suggests that stocks with a relatively low valuation (as represented by P/E, P/B, EV/EBITDA, Market Cap/Sales) tend to outperform stocks with a higher valuation, over time.

How did Fidelity come to this conclusion – how did they construct these numbers?

Here’s what Fidelity has to say about this research methodology :

“First, we identified the stocks in the BSE 500 index which have been in existence over the past 5 years (since March 2004)

We then looked at the valuation ratios (Price to earnings, Price to Book, EV to EBIDTA and Market cap to sales) as of 31st March 2004 of all these stocks

Stocks with negative EPS / EBITDA were excluded from the study as it is not appropriate to use some of the valuation ratios for such stocks

We then classified all the stocks sector-wise using the AMFI sector classification. Under each sector we segregated the list of stocks half-way into two categories – one with lower valuation ratios and the other with higher valuation ratios. For example, let’s assume we are analysing the stocks based on P/E ratio and if there were 14 stocks in a particular sector, stocks with the 7 lowest P/E ratios were categorised in the first category and the rest were in the second

Segregation of stocks was done sector-wise as most valuation ratios may not be comparable across sectors due to difference in sector characteristics

We then created two groups for each valuation ratio – the first group had all the stocks having low valuation ratios within each sector and the second group had all the stocks having high valuation ratios

The top and bottom 5% of the stocks for each of the valuation ratios were excluded from the calculation of average returns to minimise the effect of outliers

Finally, we looked at the average and median performance of the stocks in each group over the 5-year period ending 31st March 2009 to find out the relative performance of the stocks under each group”

The conclusions are fascinating and are indeed an eye-opener. How many advisors would have intuitively believed that value investing has done better than growth investing in the Indian markets? Certainly, food for thought.

A fund that plays the value investing theme is indeed worth considering as a good diversifier in a client’s portfolio that is perhaps crowded with growth style funds.