Skip to main content

Benjamin Graham’s value investing approach in Indian contest

   THE MARKETS have always had a fancy for companies on a high-growth path, giving them a premium valuation over others. Most of the investors, too, tend to follow this rule — put your money where the growth is. After all, the logic of growth — as the profits grow, so will the stock value — is so easy to understand.


   Although this popular strategy appears logical and successful, it is the contrasting investment approach of 'value investing' that continues to score over 'growth investing' consistently in the long run. Various empirical studies in different time periods and on various sets of companies have shown that value-investing — investing in companies with low P/E, low P/BV, high dividend yield — can give an investor sustained better returns over a period of time.


   The primary reason investment researchers give for this phenomenon is related to the tendency of corporate earnings growth to move towards its mean or, in other words, the sustainable rate of growth. Although growth stocks initially experience higher growth rates than value stocks, the growth rates of both quickly revert towards the mean. Both these high-growth as well as low-growth phases are temporary. But overoptimism for high-growth stocks and over pessimism for others is a universal investor tendency. According to a collaborative research work of three experts, Lakonishok, Schleifer and Vishny, published in 1994, investors put excessive weight on the recent past in attempting to predict the future. This is a common judgement error in psychological experiments and explains investor preference for glamour stocks. In the process, one of the key principles of investing is violated — good companies are not always good investments. This common investor tendency practically ensures that value investing will continue to make superior returns in a longer timeframe.


   To explain the concept in simple words, value investing is buying a stock before its growth cycle begins, while growth investing is when you enter a stock after the growth momentum becomes visible. As an investor goes on to invest in such 'glamour stocks', where the market has already discovered the growth prospects, she inevitably ends up paying a premium towards the higher future earnings. Obviously, unless you are very early to catch the trend, the growth investing approach can land you with high value stocks in which most of the upside potential is already built in the prices.


   In this context, it would be interesting to look at auto component companies such as Munjal Showa and Ahmednagar Forgings. Both these companies posted higher profits in the December '09 quarter and are well-positioned to benefit from a sustained recovery in the automobile industry. Currently, both the companies are trading only slightly above their FY09 book values. Considering the profits made during the year so far, both scrips would be trading below their respective FY10 book values.


   The key, therefore, lies in investing in companies that are trading significantly below their intrinsic value. For example, caustic soda manufacturer Aditya Birla Chemicals or the security solutions firm Micro Technologies are trading at a 30% discount to their respective FY09 book values. Both the companies were hit badly by the economic slowdown last year and are now on a recovery path. The chemical company is also expanding capacities eyeing capacity addition in the aluminium industry next year.


   When working with a large number of companies, it makes sense to use price-to-book value (P/BV) as a proxy for intrinsic value to avoid the tedious and subjective calculations of earnings projection and cash flow discounting. In fact, the study published by Bauman, Conover, and Miller in 1998, which studied 2,800 stocks in 21 countries over a 10-year time period, concluded that price-tobook ratio is a better indicator of value than priceto-earnings, price-to-cash flows or dividend yields.


   The value investing approach shuns the conventional wisdom that higher returns are associated with higher risk by focussing primarily on eliminating the risk. 'Limit the downside and let the upside take care of itself' is, in fact, one of the most fundamental principles of the value investing approach.


   This approach has a number of key benefits. First, as mentioned above, it limits the downside risk — or the risk of a significant erosion in investment value if the market falls. At a low market price, these companies have high dividend yields, which adds to the margin of safety. For example, companies such as SRF, Nippo Batteries, Munjal Showa, Cosmo Films and Shipping Corporation of India are available at dividend yields of around 4-5%.


   Many of these companies including GNFC, Shipping Corporation, India Cements and OCL India are investing significantly in their respective businesses. The expanded asset base is likely to bring in additional revenues and profits in the years to come. Most importantly, such companies can witness a quick run-up as soon as their present problems go away or sentiments improve.


   With the benchmark Sensex within striking distance of 17,700 on Friday — a peak briefly touched in January after nearly two years — and not appearing inexpensive at a P/E of 21.4, we believe investors should take a break and look out whether any value buys are around. ET Intelligence Group brings you a list of such companies that can be the starting point for the search of value.


   The primary criterion used for selecting the stocks was the price-to-book value, which was capped at 1.25. Further, the list was pruned to ensure companies with a track record of profits, positive cash flows from operations and dividends were included. Then the highly indebted companies and those earning too low a return on employed capital were excluded. Finally, companies in a perpetual downturn or with known dubious management record were eliminated.


   All said and done, investors must do their homework before staking out money in the stock market. As Warren Buffett, the great Oracle of Omaha, who has played an instrumental role in popularising the value investing approach, puts it, "Never invest in a business you cannot understand."

Popular posts from this blog

ICICI Prudential Dynamic Plan Invest Online

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   ICICI Prudential Dynamic Plan             Invest Online This fund does remarkably well during falling markets, but fails to show the same prowess during a rising market. The fund sticks to its mandate to adapt to the dynamic nature of the market by shuttling between debt and equity. It takes aggressive asset calls in equity when the market surges by investing in quality mid-cap stocks. At the same time, it adopts a defensive strategy by investing in debt and cash when markets get overvalued, making it a good long-term choice.     For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call     Leave a missed Call on 94 8300 8300   Leave your comment with mail ID and we will ...

Understanding Your Cibil Credit Information Report

   WE ARE all familiar with the anxiety and uncertainty that we feel when applying for a loan. After all, it's the lender who decides whether we can own our dream home, our first car, or whether our children can pursue higher education. In a nutshell, a better life depends on the lender's decisions.    While other factors do play a part in the lender's decision, the Cibil Credit Information Report ( CIR ) plays a crucial role in a lender's decision to approve a loan application.    Previously, lenders would treat all loan seekers equally. Each applicant, if approved by the lender's internal credit policy, would be charged at the same interest rate for a particular loan size and purpose. The lenders would charge a higher interest rate to all the borrowers, in order to compensate for the possible default of a small portion of the loan disbursed. In other words, it's like a professor (the lender) punishing an entire class (borrowers) for the mischief played b...

Financial Planner - Do Integrity & Dependability Check

How does one can find value proposition when it comes to financial planning, which is a new area? There is nothing to benchmark it with. So, how does one figure what is the right fee to pay? Look at what you want. You probably want to hire a financial planner to get a blueprint for your life ahead and want to know how to achieve your goals. For creating a tailor-made financial plan, our experience is that it takes 25-30 man-hours in all. Taking an average of Rs 500 per hour for hiring the services of a qualified financial planner like one who has a CFP(CM) certificate, the fee would come to Rs 12,500 to Rs 15,000. But the per-hour rate can be higher or lower depending on the process adopted, the experience and expertise of the planner, etc. That's how planners arrive at their fee. Now, is that value for money? For that you need to find out what benefits you would derive by engaging them. The financial plan will give you clarity, direction and pathway to achieve your goals. Th...

About CRISIL IPO Grading

CRISIL IPO (Initial Public Offering) Grading is an opinion on the fundamentals of the graded issue that reflects CRISIL's independence and expertise. This opinion is expressed as a relative assessment in relation to other listed equity securities in India. The assessment is based on a grading exercise carried out by industry specialists from CRISIL Research. A CRISIL IPO Grade 5/5 indicates strong fundamentals and a CRISIL IPO Grade 1/5 indicates poor fundamentals. CRISIL IPO Grading reflects its assessment of the graded company's equity fundamentals as distinct from an assessment of debt fundamentals. A CRISIL IPO Grade should not be construed to mean a comment on the price of the graded security nor is it a recommendation to invest or not to invest in the graded security. However, this grade is not an opinion on whether the issue price is appropriate in relation to the issue fundamentals. The grade is not a recommendation to buy / sell or hold the graded instrument, or a comm...

Mutual Fund Review: ING Dividend Yield

  ING Dividend Yield's small assets enable the fund manager to churn in impressive returns… Strategy The aim of the fund is to invest in stocks which offer a high dividend yield. This fund deploys a value based strategy which aims to gain from investing in fundamentally strong and free cash flow generating businesses. The scheme focuses not only on growth but also on the cash generated by the business, which mostly leads to stable returns even in volatile markets. This fund has a low volatility because of its investment in high yielding stocks. The scheme tries to include stocks that yield dividend above the dividend yield of the Nifty and stocks with liquidity, which throws up a universe of 150 stocks.   Our View Launched in October 2005, this fund invests at least 65 per cent of its assets in high dividend yield stocks. The fund has consistently maintained a mix of stocks across varying market capitalisation, with a higher tilt to mid caps compared to small caps. Howev...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now