Bang for your buck: How to find ASX stocks on sale
Not too long ago, in November of 2020, the investing gods answered the prayers of value investors and the market experienced a rare rotation from growth into value stocks.
Sparked by the news of successful vaccine production, value stocks, which have been underperformers over the last twenty years, rallied.
Almost nine months later, international value indexes are up over 40%. But the value domination has been short-lived. With the reinstatement of lockdowns, big tech is making its comeback, alongside growth stocks. Does this mean it's all doom and gloom for value?
According to value investors, it's quite the opposite. Indeed many believe we may be on the cusp of another surge in value stocks. So, let's get to the bottom of it.
In the first of this three-part collection, our two value experts walk through what value investing is, the power of contrarian investing, and how you should identify cheap stocks that are full of potential.
Responses come from:
Knowing it's cheap and understanding why
Michael Goldberg, Collins St Value Fund
Value investing is essentially about trying to find companies trading at a substantial discount to (my assessment of ) its intrinsic value.
This requires a lot of research and ‘hands on’ investigation because sometimes stocks are cheap for a reason – understanding what the true asset and cashflow position actually is and why the disconnect between value and price exists is the name of the game.
Key things that I look for when assessing a company include:
- A simple and established business model run by a capable management team;
- Low levels of debt;
- A stable and predictable ecosystem of suppliers, customers, employees and regulatory oversight;
- Growing earnings per share; and
- At least a 40% discount to my assessment of what it is actually worth.
My approach to value investing is different to a lot of others in that I have the flexibility of an unconstrained investment mandate. I don’t have to try and find ‘relative value’ and take positions in a stock based on its market capitalisation or sector weighting.
Rather, I have the freedom to focus on ‘absolute’ value and back, with conviction, only those ideas presenting the most compelling and deeply discounted opportunities at any given point in time.
The art of contrarian investing
Contrarian investing means we look for investments in parts of the market other investors overlook or undervalue. Our approach is based on the idea that the price the market is willing to pay for a company is determined not just by present performance, but by the market’s expectations of how the company will perform in the future.
A stock’s future performance is determined not so much by the company’s future performance, but rather by the gap between the company’s future performance and the market’s expectations of this performance.
That’s where the opportunity lies – if the market thinks a company is likely to perform terribly, and it merely performs quite badly, a wise investor should be well rewarded.
On the other hand, if you invest in a company that everyone thinks will shoot the lights out, and that company does pretty well but not spectacularly, investment returns are likely to be poor.
We concentrate on buying stocks cheaply when prevailing sentiment is poor, to mitigate the risk of paying too much. Then we exit our investment when we think a stock has reached fair value.
Contrarian investing is related to value investing, in that we often find bargains in companies trading at low multiples of earnings, or of book value.
But that’s not always the case, and at Allan Gray we are more interested in ‘value vs price’ than ‘value vs growth’ in the long term.
Stay tuned for more
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1 fund mentioned
2 contributors mentioned