The scariest times yield the best rewards

Nick Kirrage


Value stocks have copped a hammering in recent years, but there are several reasons why the investing style isn't fundamentally broken.

The last decade or so has not been kind to value investors. Not only are we that much older, we’re that much greyer as a result of performance that has left even the most hardened of us battered, bruised and battle-scarred.

Value investing involves buying stocks that are undervalued (cheap relative to their true underlying value) in the hopes that share prices will recover to reflect this true value. This contrasts with growth investors, who focus instead on the potential for growth in a company’s earnings rather than its valuation.

Value’s returns are the worst they’ve ever been

History tells us that value has been an enduring investment style over time and outperforms growth more often than growth outperforms value. But the last few years have marked the longest and deepest underperformance of value versus growth seen in recent history.

When I look at a chart like this, I think one of two things. Either it’s different this time for some reason or this is the buying opportunity of a generation, relative to other equity investments investors can make right now.

So which is it?

I don’t believe value investing has become obsolete. As a style of investing, value isn’t fundamentally broken; it’s a human phenomenon that hasn’t changed. Value investing is still about constantly exploiting the irrational behaviour of emotional investors; being brave when investors are fearful and wary when they are ebullient.

When I look at the markets or read the news, I see humans behaving like humans everywhere. I don’t think we’ve become radically more rational or less emotional.

So, if humans haven’t changed and value investing is still relevant, is this the buying opportunity of a generation?

Value stocks are as beaten up as they’ve been in nearly 100 years; investors have fled to what they perceive as the safest harbour in the current value storm: growth stocks.

How safe is the harbour?

You may be safer bobbing out at sea with a bit of volatility rather than risk being hammered against the harbour walls during the storm.

Look at what happened to Forrest Gump and Lieutenant Dan in the award-winning 1994 film Forrest Gump starring Tom Hanks. The duo join the shrimping industry with Gump’s newly-purchased shrimp boat. But the competition is tough and Gump’s endeavours are highly unsuccessful, theirnets catching only old shoes and toilet seats.

Soon a hurricane sweeps through the area, destroying all their competitors’ boats. As the sole surviving vessel after the storm, the pair have the seas to themselves and haul net after net bulging with shrimp, finally reaping the bountiful rewards of their resilience and determination.

It’s not a subtle analogy. Value as a style has performed so terribly over the last decade that it may well seem as though value managers have been fishing in the wrong seas. But for those with enough grit and patience to weather the storm, the rewards could be substantial.

The scariest times can often yield the best rewards

While past performance is not a reliable indicator of future performance, history suggests that the best time to buy (and also the worst time to sell) has been after sharp pullbacks in relative performance.

The biggest rewards can come from being brave during the scariest times. For investors willing to ride out the turbulent seas, the potential rewards could be considerable once the tide turns.

Where we are finding opportunities right now

Genting Singapore own and operate World Resort Sentosa – the man made island off Singapore that is home to Universal Studios, SeaLife Centre and a very large casino resort. It has basically got no financial liabilities and also has gross cash equating to half of its market cap. Furthermore it is trading on a 10% free cash flow yield and less than 8x normalised operating profit. Granted it is going to have very little revenue in the short term, but in the long term, it will be a survivor and is a fantastic asset.

Tokai rika specialise in auto interiors including seat belts and keys. Whether cars are self-driving or battery powered, they are likely to still have seat belts. Now auto suppliers are in for a tough time but Tokai rika have an extremely strong balance sheet. Their net cash covers ~80% of the market cap, and in terms of valuation, they trade at a 50% discount to tangible book and only 2.5 x 10 year average earnings. While it is clearly cyclical, and earnings are going down in the near term, the price looks extremely attractive for long term investors who have to take no balance sheet risk.

DeNA also have a very large cash balance, as well as a significant investment in Nintendo. Further, they are currently a third of the way through a massive buy-back utilising c.50% of their cash balance and buying back almost 20% of the shares outstanding. The operating business makes mobile games and they had been struggling to come up with new titles for a while which resulted in profits falling sharply. However, they are seeing success with a new game called 'Slam Dunk' in Asia, they have a license for Nintendo branded games, and an outstanding balance sheet to be able to invest in the business. 

If the gaming business can recover, the shares are very cheap, and if not, most of the market cap is accounted for with investments and cash, so the downside is very well protected.

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Nick Kirrage
Fund Manager, Global Recovery Fund

Nick is co-head of the Global Value team and co-manager for the Schroder Global Recovery Fund. He seeks to identify and exploit deeply out of favour investment opportunities. Nick has a degree in Aeronautical Engineering and is a CFA charterholder.

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