Stock market sentiment road map
Excitement
Optimism
A HISTORY LESSON
The concept of value investing was originated by Benjamin Graham
and David Dodd of Columbia Business School in their 1934 book
‘Security Analysis’. Although value investing can take a number of
forms, it generally involves buying securities whose shares appear
underpriced based on fundamental analysis.
Probably the best known proponent of value investing is
Berkshire Hathaway chairman Warren Buffet, who believes that the
essence of the approach is buying stocks at less than their intrinsic
value. The discount of the market price to the intrinsic value was
referred to by Graham as the “margin of safety”; the intrinsic value
is the discounted value of all future distributions.
Since the future distributions and appropriate discount rate can
only be assumptions, Buffet has taken the concept further, and for
the past 25 years or so his focus has been on finding outstanding
companies at a sensible price, rather than generic companies at
a bargain price.
Thrill
Source: Rathbones
Euphoria
Point of maximum
financial risk
him the important intellectual
distinction is not
between value and growth
styles but between value
and momentum.
“It is important to
accept that almost everybody,
when they commit
capital to an asset, does
so because the asset is
undervalued. The only
exception to that are those
investors who do adopt
a momentum approach to
the investment challenge.
“If you ask a pure
momentum investor what
the valuation of a stock
is they will say: ‘I do not
care’. They will simply
continue to hold it until it
stops going up.”
l Mind the gap
Anxiety
Denial
Fear
Desperation
Panic
A fine analogy of this
was used by Peter Lynch,
Where we are now
Point of maximum
financial opportunity
Optimism
Relief
Capitulation
Hope
Despondency
Depression
former manager of the
Fidelity Magellan Fund.
You are standing on a platform
at an Underground
station and when the train
comes in, an announcement
says it is going to
crash within the next ten
stops. A momentum investor
will get on and gamble
that they can get off in
five or six stops. A value
investor, on the other
hand, would not get on
the train at all.
On the question of
whether one should adopt
a value strategy today,
Stick says it is very difficult
to answer.
“The market has had
a tremendous run from
March last year to now,”
he remarks. “By definition,
much of the value that
was there must have been
swept away. If you believe
the emerging markets story
– that China will continue
to consume and commodities
will continue to rise
– that does not suit value
at the moment.
“But the market is not
pricing in a lot of the bad
things. We do still have
issues with financial asset
prices in the US and lowdoc
or no-doc mortgages
which will need restructuring
this year.
“There are issues with
sovereign debt – Greece
has not been sorted out.
There could be something
that happens that forces
the market back down
again.”
Stick continues: “The
market could go higher
but are we storing up
problems? Or do we take
a value approach and
retrench, knowing we may
underperform for a period
of time? From my point of
view, we do the latter. We
may underperform for a
period but over time that
margin of risk will eventually
come through.”
l Trick of the trade
Anyone can point to one-
or two-year periods where
value has underperformed
but over time it does tend
to outperform. That is why,
says Stick, the great investors
tend to be value investors.
The key is to know
what mistakes have been
made in the past and to be
disciplined on valuation.
“There are no definitive
answers about something
as enigmatic as the capital
market,” Train observes.
“The most important thing
as an investor is to get
your head straight. What
approach is most likely to
work for you?
“For some, being an
aggressive trader and a
momentum investor works.
For others, being a stub-
THE CONTRARIAN VALUE INVESTING
born, deep value investor
fishing around the bottom
looking for a pound of
assets for 20p works.
“They are completely
different mindsets.
Proponents of both can
point to it and say it works.
I wouldn’t claim what I do
is right or correct but we
would feel psychologically
uneasy if we bought assets
we couldn’t demonstrate
are undervalued.”
l No second guessing
Train believes that hindsight
suggests there are
points in the cycle when
we do well and not so
well. But he adds that it is
difficult to know when it
will change.
“Long ago we stopped
trying to pre-empt those
changes. We stick to what
we do. What we will not do
is try and flip-flop between
different styles – that can
be worse for the client.
“I do think it is clear
there are certain stock
market environments
where momentum-oriented
strategies do very well.
During these times there
is an emerging then
strengthening mania for a
given asset class: in 2000
it was tech and in 2006-07
it was the mining boom.
There is a period where
momentum investors do
incredibly well.
“Everything associated
with that does extremely
well and everything based
on fundamentals gets left
behind. I can remember
in 1999 and 2000, unless
you owned that [tech] stuff
you were toast. Maybe at
that level if you feel it is
important to be performing
well the whole time
and you see an emerging
mania you should seek out
managers who are pinning
their ears back and buying
these things.”
“
There are no
definitive answers
about something
as enigmatic as the
capital market. The
most important thing
as an investor is to
get your head straight.
What approach is
most likely to work
for you?
”
Nick Train, director,
Lindsell Train
SUMMARY
Value investing can be defined
as seeing an opportunity in
an asset or share where the
price the market is offering
the asset at now does not
reflect the true intrinsic
value of that asset.
It could be argued that all
investors are value investors
as they all buy assets on the
basis that they will go up.
Value investors may
underperform when there
is considerable interest in a
particular asset class, such as
during the 2006/07 resources
boom, when momentum
investors will outperform.
MAY 2010 [www.portfolio-adviser.com] PORTFOLIO ADVISER
47
To view a Ceros magazine you need to have JavaScript enabled in your browser and have the flash player 8 or higher installed. To install the latest flash player, click the icon above, install the flash plugin and then click here to refresh this page.