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The stock markets of recent times have been rather uncertain. Volatility has been rampant, but there have also been unexpected results of late. For the first time, the BSE Sensex breached the 50,000 mark. This is colossal considering that the COVID-19 pandemic pulled the Sensex to a record low in March 2020 and in just 10 months there has been a turnaround from 25,000 to 50,000.

This tremendous move has not fared well for value investors who have been questioning these absurd valuations. Markets seemed to have largely ignored these questions and continued to boom. This brings us to the question: Is value investing dead in the current market scenario or are we missing something?

Before diving into value investing, it is important to understand fundamental analysis. Fundamental analysis is a method of measuring the intrinsic value of a security by examining the economic and financial factors involved. Fundamental analysts study various factors, from macro economic factors to quantitative micro factors like a company’s financials and qualitative factors like the management’s efficiency. The end goal is to arrive at a value for the company’s stock or its business, which brings us to value investing.

Value Investing is an investment strategy in which a person buys securities when they are underpriced and sells them when they are overpriced. The value is derived by conducting fundamental analysis, the crux of which is valuation. Valuations can be of various types, each investor might have their own method. However, they can be broadly broken down into two types. The first being Intrinsic Valuation, where the present worth of the business is derived on the basis of future expectations. Secondly, Relative Valuation may be used to derive the value of the business by comparing it with similar businesses.

Value investing, which originated in the 1920s, was popularized by Benjamin Graham, who is called the father of value investing. However, times have changed, so have the stock markets, and it would be perhaps erroneous to assume that strategies that worked back then are going to work with the same effectiveness today. Furthermore, given how dynamic stock markets are – value investing has come under close scrutiny. It’s not just the common masses raising a question on value investing, even Edward Chancellor (noted financial historian) states that the credit crisis had uncovered a profound weakness in Benjamin Graham’s strategies, and believes things could get even worse for the disciples of Graham.

Valuation in itself has certain drawbacks. The biggest of all is bias. Bias can be positive or negative and it can be due to internal or external reasons. For instance, if a consumer loves Marie Gold, Good Day, Bourbon and the entire Britannia biscuits catalogue, they’d be prone to believe that the company is great too and the stock should perform well compared to its peers. Bias subconsciously can drive a person to inflate projections. Positive bias is so prevalent that it might be a reason why there are 9 times more buy calls than sell recommendations. The second major reason why value investors fail is that individuals believe valuation is all about numbers and financial statements. To quote the words of the dean of valuation, Aswath Damodaran – “The biggest hidden secret in valuation is that it can never be just about the numbers, if all you have is a collection of numbers on a spreadsheet, you don’t have a valuation, you have a spreadsheet”. Investors need to draw a bridge between the story and the numbers. Every projected number should have a story attached to the company, as to what really gives the company this kind of growth or slack. This method ensures that the valuation factors in the qualitative as well as quantitative aspects of the company’s performance.

The value of a company is driven by its growth, earnings, cash flows and risk fundamentals. One major catch in intrinsic valuation is the assumption that markets make mistakes and they will correct them in the future.This means that the entire market and the demand-supply equation is currently valuing the company wrong, either overpricing it or underpricing it.

However, it will correct itself later. What needs to be addressed is how long the markets will take to correct themselves; one year, five years, a decade or forever? No one can know. The rationale of value investors is to be patient and wait, therefore it wouldn’t be appropriate to call the strategy dead on short term failures.

Many value investors believe that because they have crunched the numbers and have derived a figure, they ought to be well rewarded in the market. However, markets don’t always function in this manner. The disappointment caused by this failure often causes dejected investors to lose faith in their valuations and commit mistakes like selling off at lower prices or buying at higher prices. Further, it is important to understand how the dynamics of business and competition has changed. Fast-changing technology and consumer choices do not only create a need for companies to be aggressive but also alter the life cycle of companies. There is a greater need among investors to be well aware of the surroundings of their portfolio companies.

Value investing gives a logical backbone to the decisions taken by investors. It cannot eliminate uncertainty but act as a tool to manage it. It acts like a life jacket to risk-averse investors in the volatile markets, while making sure they are well rewarded. However, these rewards cannot be the same for every stock, every time frame and every individual. The other justification for having confidence in valuations is that there are credible reasons and evidence of its success in history. A good valuation should be able to factor in every aspect of the company and macro variables, and should not affect decisions due to short term bull or bear runs.

There have been various new investment strategies that have creeped up the markets like that of growth investing and momentum investing, and yes, they have done wonders for many, whereas on the other hand have made many bleed. This does stand true for value investing too. While investment strategies cannot be judged upon based on short term results, they also cannot be judged based on what works for one or even the majority. Investing is indeed an art that differs from individual to individual.

By Tushar Mandhana


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