Every downturn provides opportunities for the value investor. Stocks that are solid performers get sold along with everything else and tainted by association if they are in an unpopular sector.
The basis of value investing is to find good companies that have been underrated or overlooked by the market. But identifying value can be tricky. Sometimes a stock is sold down for a good reason: its prospects may not be good and in this climate it may fail because of debt. The stock picker has to be brave or have done their research well to stand against the prevailing wind.
MLC Investment Management senior investment specialist John Owen says value investing is probably the hardest style of investing “because you are buying companies that nobody wants to invest in – that is why they are cheap – so it takes a lot of discipline and a definite mindset.”
He also says there are different styles of value investing. MLC uses four value managers for its Australian shares portfolio and Owen says they all approach value in a very different way and look at different sectors of the market.
A classic value play is to find a company that has been punished for a mistake, buy in and wait for the turnaround, a strategy that has put property trusts on some buy lists. Owen says investors have to consider how long they are prepared to wait for stocks to get re-rated and notes fund managers can be prepared to wait two or three years for a stock to turn around, “it takes time to be proved right.”
Some value adherents stick to the top 50 or 100 stocks but others look beyond, believing there is good value in many smaller companies. The trap here is that they may continue to be ignored because they are not big enough to come onto the radar screens of fund managers or many stockbrokers.
Private Portfolio Managers managing director Hugh MacNally sees value in Origin Energy. Although it was one of the market’s better performers last year, MacNally says lack of news around the stock has seen it in limbo recently. He values the stock at over $20 and notes that when Origin came under takeover offer from Britain’s BG last year, analysts were putting valuations in the high $20-mark on the company.
MacNally still sees value in the banks despite their recent run. He says Private Portfolio likes companies that have a strong strategic position in their industry and REA Group, owner of realestate.com.au, fits the bill as the dominant real estate advertising site. MacNally says the subscription fee is so low that real estate agents cannot afford not to subscribe to the site “it is like not having a telephone.” He says REA has fallen in the past month because of reports that Google will enter the market but he does not consider this much of a threat and it has provided a buying opportunity in REA.
MacNally also likes Melbourne IT and is forecasting a strong second half result. He says the IT company has a good management team and is very cheap based on its long term growth.
Broker Stephen Fulton of FW Holst, who writes his own value investing newsletter, rates QBE, National Bank, Rio Tinto, Telstra and Westfield as underrated value stocks. He says they are on low price-earnings ratios despite recent rises.
Fulton is sticking to the top 20 stocks by market capitalisation, saying his back testing shows they are the best performing value stocks, so he is looking at blue chip companies with a low P/E ratio.
“They have much more staying power and are more stable in a down turn. If you had bought these stocks in the last 18 months you would eventually be back up to the top again,” he says.
Zurich’s director of investments Matthew Drennan says now is a good time for value investment but with markets focusing on debt levels and interest cover ratios, investors need to be confident that company debt is manageable. They need to look at net tangible asset backing and watch out for companies needing to raise capital at any price.
Drennan likes the major banks, believing the market has underestimated the lack of competition from regional and foreign banks. He says the bigger end of the resource sector also offers value as companies can access capital more easily than smaller players and China continues to demand their product.
Drennan also sees value among the A-REIT sector “where a lot of mid-tier stocks have recapitalised and paid down debt.” He sees a return to the “plain vanilla rent collecting style” which made property trusts so popular with investors for years and says there will be more stocks offering good, steady yields.
MLC’s Owen says that part of the discipline of value investing is to know when the stock is no longer cheap, and it can be hard to go against the flow when everyone else has discovered the stock and rates it as a buy. “You have to have the discipline to sell out and not fall in love with the stock.”
* at 10/8/09
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