By Arney Tjaro
When analysts discuss value investing, they often invoke Warren Buffett and Charlie Munger, alongside their celebrated investment philosophy.
Digging deeper, the discussion frequently shifts to relative valuation metrics; Price-to-Earnings (P/E), Dividend Yield (DY), Earnings Per Share (EPS), and Price-to-Book (P/B) ratios, as tools to justify why a particular stock is an attractive buy. But is that the full extent of value investing?
Not quite. A key, often overlooked, aspect of value investing is considering the business cycle phase that a company is in.
For instance, a company may appear attractively valued after 150 years of operation, but this could simply reflect the depletion of its growth potential, indicating it’s time for a strategic pivot.
This phenomenon is not new to the Johannesburg Stock Exchange (JSE), as evidenced by Rembrandt International’s spin-off into Richemont and Remgro.
The undervaluation of the JSE may be to some extent due to mature companies clinging to growth narratives despite stagnant business models.
This could explain the surge in delistings in recent years, with firms like Ellies failing to adapt and companies like MultiChoice which almost followed suit due to an inability to keep pace with evolving technology and consumer demand.
Where am I going with this, you may ask? In today’s era, technology has provided investors with sophisticated tools to aid investment decisions.
However, paradoxically, more information and advanced valuation tools seem to have led to worse performance. This is highlighted by the SPIVA U.S. Scorecard Mid-Year 2023, which shows that over 10, 15, and 20-year periods, 85.61%, 92.19%, and 93.58% of large-cap U.S. equity funds underperformed their benchmark (the S&P 500), respectively.
The likelihood of underperformance increases over longer time horizons, making it challenging for even seasoned fund managers to beat the market.
Equity returns consist of dividends, earnings growth, and changes in price-to-earnings (P/E) multiples.
On the Johannesburg Stock Exchange (JSE), the period between 2014 and 2018 illustrated a shift where returns were increasingly driven by expanding valuation multiples rather than earnings growth and dividends, marking a deviation from the historical norm.
In an environment where returns rely heavily on less predictable factors, like P/E multiples, fundamental value investors face a disadvantage. Low earnings growth further exacerbated this trend, making it difficult for investors to secure returns through traditional earnings growth.
Being a value investor does not mean focusing solely on fundamentals when making investment decisions. Too much reliance on those factors, including data, can be counterproductive.
Instead of being purely “data-driven,” investors should aim to be “data-informed.” Historical data provides context, but it cannot predict future trends. Recognizing this can lead to more realistic valuations.
Sometimes, investors must rely on intuition, guided by a company’s narrative, rather than getting lost in quantitative data.
Valuation today should center on storytelling through numbers. Intuition involves understanding where a company is in its life cycle, its value proposition, and how it intends to execute its strategy.
As Leonardo da Vinci wisely put it, “Simplicity is the ultimate sophistication.” Money is ultimately made by doing something well. The oversight that many investment managers make is fixating on valuation metrics, dividend yield, P/E, EPS, P/B, EV/EBITDA, like peering through a keyhole at a vast landscape.
Great investors focus on how well a company operates under different conditions, which ultimately reveals its true value.
*The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the official policy or position of any associated organization, employer, or company. Arney is a young investment professional with 5 years of experience in economics and finance, specializing in fixed income and equity research analysis.
