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It can be overwhelming for investors to figure out where to put their hard-earned cash to hopefully generate healthy returns.
But that’s where having an investment strategy can help.
Are you looking for for dividend income in particular, or have a long timeframe and want more risk on growth stocks?
Another alternative is value investing – pioneered by Benjamin Graham and and with aspects followed by the likes of Warren Buffett.
Here, The Independent explores value investing, what it involves and what you need to know.
What is value investing?
Value investors look for high-quality companies with strong fundamentals that trade below their intrinsic value – in other words, what the company is worth at a given moment based on assets, projected cash generation through sales and so on – so they can buy shares at a discount, before the market catches on.
Companies can be undervalued for many reasons, such as short-term setbacks, or negative sentiment over future growth.
Sheridan Admans, chief investment strategist at Infundly, says value investing can offer balance, as many portfolios are heavily exposed to large, expensive growth and technology companies.
George Godber, UK value manager at Polar Capital, is optimistic about value investing, flagging it “has a good track record of delivering returns, especially in the UK.”
open image in galleryHow do experts find value stocks?
Value investing can be challenging, so we asked some experts how they find value stocks.
Wes McCoy, fund manager of Aberdeen UK Value Equity Fund, says investors must think about why a business is being undervalued, why this could change, if this is likely to happen and the time horizon.
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Godber, meanwhile, looks at whether the shares are cheap, or if the market is under-appreciating the profit and return on capital the company could make. He also explores whether a company’s assets or profits will improve over time, and if the business generates enough cash to weather any challenges.
There are many metrics investors use to find value stocks, including the price-to-earnings (P/E) ratio, which shows how profitable a business is by revealing how much an investor is willing to pay for each £1 of a company’s earnings.
However, Admans says value investors rarely rely on just one metric, flagging that a low P/E ratio “can be misleading if profits are about to fall, or the business is in structural decline.”
Which companies are seen as value stocks?
The UK market has been “out of favour for years, and trades at a discount to many overseas markets,” with value investors looking at banks, insurers, energy, mining, utilities, and some industrial businesses, as they tend to have tangible assets, visible cash flows or dividends, and depend less on long-term growth assumptions, according to Admans.
McCoy currently focuses on digital businesses assumed to be “big losers from AI,” such as AutoTrader, Future, Mony Group, and Rightmove, believing their established market position is underestimated.
Godber says certain sectors have done “very well” in the UK in recent years, including banking and mining, but flags that AI is causing huge disruption for some industries.
“The UK is thankfully, as a market, not exposed to many of these, with a particularly low weighting in software, relative to other indices,” comments Godber.
Barclays and Dr Martens
It’s worth briefly explore some companies experts are looking at.
McCoy says Barclays’ earnings potential is undervalued, and believes improving returns on assets will push the bank forward, “which has played out very successfully in recent years,” due to the changes in the interest rates.
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open image in galleryShoemaker Dr Martens, meanwhile, is seen as undervalued because it “was run poorly,” according to McCoy.
While it has global appeal, management must improve “how they sell,” and may benefit from a “better consumer environment” – but the latter is out of their control, so investors must be patient.
That’s often a trait value investors need to possess, in fact.
GSK and Shell
Godber says the energy giant Shell, and the pharmaceuticals and biotech company GSK, are similar.
Both have new management teams that focus on making sensible decisions to increase profit margins, running their businesses better and improving cashflow.
A key factor for valuations of both companies is whether they can meet their targets.
He flags there is debate around GSK’s aim to reach £40bn of sales by 2031, and a 30 per cent operating margin, while Shell is aiming for a 10 per cent rise in cashflow per share by 2030 and aims to distribute 40 to 50 per cent of cashflow to shareholders. That is usually through dividends or share buybacks.
What should investors consider?
Value investing may appeal to risk-averse investors, as they tend to have lower volatility than growth stocks, and are more likely to pay dividends.
However, be wary of so-called value traps: companies that are cheap for a reason, and at risk of further share price falls.
If you want to invest, it’s important to understand your temperament, risk tolerance, and objectives, according to McCoy.
With individual stocks, hard work and research is needed, says Godber, although an alternative is to invest in a fund to spread the risk.
If you decide to use a value fund, McCoy flags they can be “contrarian” and look “different from the norm” as a result.
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.