Though value investing may mean different things to different people, it is, by and large, an investment style wherein a buyer picks a stock trading at a significant discount to its intrinsic value. In other words, the goal of a value investor is to find companies whose stock prices do not reflect their fundamental worth.
There could be numerous reasons why a stock might trade at a discount to its intrinsic worth. It could be because of a dent in the company’s earnings or an external event may have temporarily depressed its stock price. A value investor would look at it as a long-term opportunity.
When buying such stocks, these investors will look for a “margin of safety”. This means that the market has discounted a stock more than it should have, making its market value less than its intrinsic value. Simply put, a stock trading at Rs 75 when its intrinsic worth is estimated at Rs 100 makes it a good buy.
India being a fast growing emerging market economy, it is not surprising to find the asset management industry dominated by growth fund managers. Less than 10% of Indian equity fund assets are in value-oriented funds. The two prominent value funds which have been in existence for a while are ICICI Prudential Value Discovery and the Templeton India Growth. There are others too — PPFAS Long Term Value Fund, Templeton India Equity Income Fund (which have the flexibility to invest in international stocks) and L&T Value Fund.
Worth mentioning is that most Indian investors also recognise the dividend yield theme as value investing. If that is the case, then there are such schemes from other fund houses — Birla Sun Life AMC, BNP Paribas Asset Management, Principal PNB AMC, Tata Asset Management Ltd and UTI AMC. Let us now take a look at dividend yield funds.
Yielding dividends
Most of these funds have dividend yields between 1.5% and 2.5% compared with 1-1.5% offered by the benchmark. While these products offer “value” compared with a growth fund, the margin of safety is actually very thin. Also, the dividend yield on these funds is not really attractive compared with fixed income, with the 10-year yield in India at around 8.5%. Compare this to the scenario in the U.S. where dividend yield funds offer a yield in the range of 3-4%—currently better than the U.S. 10-year yield. This makes it an attractive proposition for American investors to look at dividend yield funds as against investing in fixed income given that they also offer the opportunity to participate in the growth of these companies.
Ratios to look at
Value fund managers in India do look at the intrinsic value of stocks while investing. The low price-earnings or price-to-book-value ratios, which are at a 15-20% discount to those of diversified funds, are also a testament to this value bias. The low turnover ratio of these funds points to their buy-and-hold investment philosophy, which is consistent with value orientation. Templeton India Growth Fund had a turnover ratio of 7% while for ICICI Prudential Value Discovery Fund it is around 36%. By itself that may seem glaring, but its low when compared with a turnover ratio of more than 100% for the diversified fund category.
Picking value
The other feature of value funds is their orientation towards small- and mid-cap stocks. The primary reason for this would be that most of the large-cap stocks in India are well researched, so identifying “value” in this space becomes difficult. But, it is easier for a well-resourced research team to identify stocks at attractive valuations in the mid- and small-cap space.
Templeton India Growth Fund tends to be more large-cap-oriented with allocation of around 40-50% in these stocks, while ICICI Prudential Value Discovery tends to be more mid- and small-cap-oriented with allocation of 60-70% in this space. Templeton India Growth Fund also has a concentrated approach of investing in 20-25 stocks while ICICI Prudential Discovery Fund is more diversified with 50-60 stocks. One of the reasons for this diversification could be the larger fund size in the case of ICICI Prudential Value Discovery Fund.
To the credit of both these funds, while there have been periods of underperformance in the bull market of 2005-07, they have beaten the benchmark over longer time frames. However, a fund like ICICI Prudential Value Discovery also tends to look at relative valuations of stocks, which can become a concern when the entire market is overvalued.
Quantum Long Term Equity Fund adopts a different approach where it tends to increase exposure to cash if there aren’t enough investment opportunities. The fund manager prefers to buy stocks which are trading at a 40% discount to the intrinsic value. So in the current scenario, where most stocks have shot up, the fund manager has preferred to stay in cash to the extent of more than 30% of the portfolio. This high cash component can lead to underperformance in a bull market, but the strategy has so far paid-off for its investors.
Long-term investors must look at some of these well-managed value funds. They are a good diversifier in a growth-oriented market such as India.
This article was originally published in Mint
