Value investing 2.0: the importance of taking a broader view of value
Momentum, quality and growth: these style factors have delivered reliable returns in recent years. Investing in value stocks - value investing - took a bit of a back seat as a result. Nevertheless, value remains an indispensable factor for investors with an eye on solid fundamentals and long-term results. But just as markets evolve, so classic value investing also needs to be updated.
Value has become a kind of ‘anything-but-Magnificent-Seven’ narrative today. But that doesn’t always have to be the case. Several ‘Magnificent Seven’ stocks and other tech growth big guns, such as Meta, Microsoft and Apple, were a clear value play in the past. So value investing in, say, an undervalued semiconductor producer is also possible.'
Jeroen Van Boeckel, Investment Strategist at KBC Asset Management
Value investing is all about selecting stocks that are listing below their intrinsic value. The method has been criticised for being incompatible with current economic realities. 'The importance of physical infrastructure such as factories and machinery is decreasing, while by contrast the importance of intangible assets is increasing,' says Gert Elaut, Portfolio Manager at KBC Asset Management. 'The problem is that within classic value investing, investments in Research & Development (R&D), human capital, data, brand value and so on are not seen as investments from an accounting perspective. Yet these too are things that can generate future value. Those who do include these intangible assets in the value analysis find that some companies which at first glance appear more expensive suddenly become a lot more attractive.'
Tech versus the rest?
Classic value investing often leads to a tilt towards certain traditional sectors such as consumer goods or telecoms companies. Technology companies are mostly left out of the picture. 'Innovative sectors are harder to fit into the old framework of value investing,' says Jeroen Van Boeckel, Investment Strategist at KBC Asset Management. 'Value investing may have become a way to diversify an investment portfolio and protect against over-concentration, but a traditional definition of value can also cause investors to miss out on potentially interesting opportunities outside those traditional value sectors. Tech companies often have very few physical assets, but growth expectations are also high. It is that second element in particular that is difficult to reconcile with value investing. In that respect, value has today become a kind of ‘anything-but-Magnificent-Seven’ narrative. But that doesn’t always have to be the case.
Take Apple for example, a tech stock that is synonymous with growth and momentum. Warren Buffett, one of the best-known value investors, bought the stock in 2016. 'An atypical move for a value investor, you might think, were it not for the fact that he bought Apple at a price-to-earnings ratio of just under 10. Today, the P/E ratio is over 30 ... perhaps also one of the reasons why he has been reducing his positions lately,' Van Boeckel continues. The message: It is a misconception that value investing should not allow for companies to grow, or that they must be in a financial bind. Several ‘Magnificent Seven’ stocks and other tech growth big guns, such as Meta, Microsoft and Apple, were a clear value play in the past. So value investing in, say, an undervalued semiconductor producer is also possible.'
The value of a stock lies not only in tangible assets, but also in intangible factors such as Research & Development, human capital and brand value.
Gert Elaut, Portfolio Manager at KBC Asset Management
Value investing 2.0: looking ahead with fresh eyes
In a world where the economic dynamics are changing rapidly, value investing requires a broader analysis. Whereas previously the main focus was on book value and classic ratios such as price-earnings ratio and dividend yield, today investors need to develop a broader view. 'Value investing 2.0 means looking not only at a company's tangible assets, but also at the intangible elements that create value,' Elaut says.
'As with the traditional value approach, the starting point remains one of looking at cheaply valued companies regardless of sector or region. On top of that, we refine the criteria. Three perspectives are important here: balance sheet, income statement and free cash flow.'
- As regards the balance sheet, Elaut adjusts the book value to allow for internally created intangible assets. These are mainly R&D and human capital. He also applies a correction for externally acquired intangible assets, for example what we call 'goodwill', the premium paid on acquisitions.
The aim? To arrive at a more precise definition of book value. - Whereas the income statement traditionally starts from the P/E ratio, Elaut looks at EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) over EV (Enterprise Value). The aim? To obtain a fairer picture of a company's profitability.
- Free cash flow also counts. After all, the value of a stock comprises the present value of future cash flows.
The aim? To the extent that those cash flows are distributed to shareholders, they form a significant part of the total returns.
Emotions can be fickle, but value is measurable and patience is priceless.
Jeroen Van Boeckel, Investment Strategist at KBC Asset Management
Is boring the new sexy?
Value investing does require active management. 'A stock that looks cheap is not necessarily a good buy. 'Often there is a good reason why a stock is cheap,' Van Boeckel says. 'That’s why it is crucial to look beyond the numbers. You also need to understand the story behind a company. The quality of management, the sustainability of the business model, these are all elements that play a role in the analysis.'
'Which is not to say that once you’ve done your analysis, you can adopt a buy and forget strategy,' Elaut adds. 'Active follow-up remains necessary. Always. 'Intrinsic value is not static, but evolves over time.'
'Besides in-depth analysis and continuous monitoring, patience is an indispensable trait for any value investor. It can sometimes take a long time for the market to recognise and acknowledge the intrinsic value of an undervalued stock. True golden opportunities are rare, so when a good idea presents itself, you need to give it the space to fully develop,' Van Boeckel concludes. ‘Emotions can be fickle, but value is measurable and patience is priceless. In the world of value investing, boring is good. Buying quality at a low price is often a strategy that pays off.'
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The information contained in this publication is for information purposes only and should not be considered as investment advice.
