This week the Financial Times ran an article stating that value investors were suffering due to QE. See - Value investors suffer during steady QE rally by John Authers of the 1st April 2015.
In the article John Authers argues that value investing has been receiving criticism for not performing as well as expected and that it only works when things look terrific or terrifying.
The feud over which investment strategy is best, value or growth investing has been a topic of much debate in forums and comment streams recently.
In this discussion, we prefer sitting on the fence because we see the value in combining both strategies.
Value investing is based on buying a stock that is trading significantly below its intrinsic value. Buying the stock at a discount leaves a margin of safety for the investor.
Growth investing revolves around the strategy of buying a stock that shows great growth potential. For instance, a growth stock will be a company whose earnings are expected to grow at an above-average rate compared to its industry or the overall market.
The key lies in melding the two concepts of value and growth.
You are making a mistake if you think you can purchase a value investment based on one measure (discount from book value or even low PE Ratio) alone. There are many metrics to consider when evaluating a business and its equity. Use the following metrics when evaluating assets: 6 Vital Value Investing Metrics.
Our analysis has shown that you have to look at three dimensions.
1. Fundamental Analysis
- We use the strength of the company to determine how well a business operates in its sector. Does the company manage its cash efficiently, organises its balance sheet and how well is the company run?
- We look at returns because an investor should expect investments to generate returns that significantly beat the rate of interest offered by the bank.
- We calculate the intrinsic value of a business by taking a unique view of balance sheets. We strip away anything intangible or shady, such as accruals, and add charges that we believe are missing, such as amortisation, writing down intangible assets. Soft assets such as patents and goodwill are discounted.
- We look specifically for companies that can afford paying dividends on a regular basis from free-cash-flow within the business. We take a close look at the dividend history of a business to get the full picture.
- Earnings predictability is a blended metric that considers how the management team values growth. It is a historical look at growth across revenue, gross profit, overheads, EBIT and net income.
- Economic moat is an important factor to consider before buying any company's stock. Ask yourself: does the business have the ability to withstand external market forces and how protected it is from competition?
We determine a fair value based on future growth and free cash flow. You can then set an entry price based on a suitable margin of safety.
Intrinsic value, or true book value, is only one of the factors we analyse in order to reveal the fair overall value of a business.
By combining future growth forecasting, cash per share, terminal value and net present value for example, we are able to see a far more rounded view of business value. This is why we call it fair value.
The down side of using only the intrinsic value of a business to determine whether its current share price is accurate, is that it does not take into account the trajectory that the business is likely to take. While we are interested in the snapshot of where a business currently stands, we also need to get a good idea of where it is heading.
Too often, value investors buy a stock on its way down and take the pain of the downward decent. A bit like catching a falling knife. We look for the price to stabilise or recover before entering.
The STRIDE engine helps us identify the upswing, recovery or momentum in a stock after a large dip. It also detects good targets that are already experiencing upward momentum and have not suffered a dip.
The engine buys recovery instead of weakness. It gets you in earlier on outright winners and buys the recovery of unloved shares. You can learn more about the new timing engine by reading: Optimised Buying Opportunities with the New Timing Engine.
Lastly having a sale point where you exit a business is key. Again this should be based on the fair value with a suitable margin to give you ample reward for exiting the investment.
In my experience (as an average investor) following these simple rules works consistently well regardless of QE. There seems to be no shortage of great companies that get ignored by the market which end up providing great returns.
For instance, if you take a look at the Little Acorns portfolio, Sally has achieved 12% returns after only four months of investing. She achieved these market-beating returns by simply applying the three dimensions of 3D Value Investing. The Little Acorns portfolio proves that combining both value and growth strategies have great benefits for all investors.
Long live 3D Value Investing!
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