'value investing' - Happy investing!

After the carnage witnessed on the first trading session of the week, the markets displayed immense volatility yesterday, yet managing to close in the positive. The pressure was triggered by apprehensions regarding the Fed continuing with its stance of raising rates, which could have a restrictive effect on global economic growth.
This makes us reaffirm our belief that investing is a long-term game that requires not only skills but also patience. The factor, which separates investing from speculation, is the well thought out planned approach for deploying funds which speculation lacks. Speculation is about maximizing your return in the shortest time (though undertaking high levels of risk), while investing is all about garnering adequate returns from a well thought out investment strategy.
Various investment styles have been popularized to beat the street in the past. One of the most popular styles, which date long back, is 'value investing'. Benjamin Graham, the father of investing, popularized this style of investing, which is the method of picking up undervalued stocks and holding them over a long-term. The value of the stock is worth the future cash flows (that can be taken out of business) discounted to the present value. Simply put, value investing means (attempting) to buy 'something' for less than it is real worth.
Parameters of value stock selectionGood value means buying of shares of companies, which have low price earnings ratio, high asset backing, high dividend yield, robust business model and clear and visionary business mission. The management creates value through its policies. Thus, value investing dwells into all aspects of business and tries to visualize the impact of business policies on the earning potential of the firm.
Value investors also look for bargain prices (priced low for temporary or irrational reasons, under-priced in relation to the company's potential). According to Benjamin Graham, value investing consists of patience, common sense and in-depth analysis of published information. It also involves contrarian investing, which says - 'hunting when hunters have left.' Value investors look at margin of safety. They look at buying stocks at maximum discount possible on their intrinsic value. Though the subject of intrinsic value is a matter of subjectivity. Value investing involves separating emotions from investing and investing on a common-sense basis. The investors following value investing ignore market sentiment, short-term swings and other factors affecting stock prices.
Thus in conclusion, you, as an investor, need to compare intrinsic value of the company as a whole to its current market capitalization. Success will, however, depend on skill in accurately determining the intrinsic value. It can also be said that to be a good value investor, one needs to harness the qualities of a contrarian investor, a patient investor, a rational investor, an analytical investor, and above all, a long-term investor.

The fact that the Indian stock markets, and for that matter even the global markets, have had a very volatile week is not a news to anyone. From our perspective, falling stock markets offer significant buying opportunities for long-term investors. It is time to take a long-term call and invest.
Instead of focusing on the gainers and the losers in the last one week, in this weekly round up, we have focused on macro issues and how they will impact the stock market performance over the next two to three years. We have consciously stayed away from sounding ‘we said so’.
Random thoughts on the current trends…On Thursday, the benchmark BSE Sensex fell by over 826 points. Investors attribute the same to largely three factors.
The recent inflation report in the US and the Federal Reserve’s stand on interest rates did raise concerns among the global investing community with respect to whether there is a possibility of interest rates rising much faster. Commodities, including crude oil and gold, witnessed significant correction.
Secondly, domestic investors were ‘concerned’ about the prospects of new tax being imposed on select FII trades, which the Finance Minister later denied.
Significant unwinding of open interest position in the futures and options market.
If the proposal to tax FIIs was the reason for the Thursday fall, even after the FM clarification on the issue on the same day, what triggered the fall yesterday? We do not have answers to that and neither do the market participants. But one thing is for sure. It is time investors in India recognize the fact that global factors can have a dramatic impact on the Indian stock market performance. Till now, the increase in interest rates, including US, was sidelined with a view that the ‘India story’ was on a strong footing. Indeed, we subscribe to the India story. But we also acknowledge the fact that the investment decision of FIIs depends on their evaluation of ‘India’ and its valuation in relation to other emerging markets.
Valuation conundrum…As our subscribers are well aware, we have recommended a Sell on stocks from sectors including engineering, power and cement purely based on fundamentals. Why should a ‘X’ cement company (and that too, a regional one) trade at a EV/tonne (enterprise value per tonne) of US$ 200 when the best of cement companies in the global markets are trading between US$ 125 to US$ 150 per tonne.
Similarly, why should an engineering company trade at a price to earnings multiple of over 40 times trailing twelve months earnings when the best of the engineering companies globally are trading at less than 15 times trailing basis. Yes, growth is robust, but we do not wish to upgrade our valuation multiple just to make sure that we have a ‘BUY’ rating on a stock. But yes, we have reviewed our valuation metric and wherever it was necessary, we have upgraded/downgraded our valuation multiple to reflect the fundamental change in the sector.
We continue to believe that certain stocks from sectors are trading at rich valuations and we see downside risk outweighing the upside potential. That said, even at these levels, we do recommend our subscribers to invest in stocks from a long-term perspective, provided the valuations are justified.
Where to from here?As we mentioned in our view on the market after the Thursday fall, this decline should be taken as an opportunity to invest and build a long-term equity portfolio. Needless to say that the equity component of the overall asset allocation should be in line with one’s risk-return profile. We would also like to remind investors that with the rise in interest rates (and prospects of further increases), debt is becoming attractive.
Therefore, we suggest investors to invest in short-term fixed deposits or floating rate funds that further invest in shorter duration government securities. Overall, you, as a retail investor, should not shy away from equities given the recent decline in the stock market. Invest in good companies with a sound business models (i.e. ability to ride through cycles) from a two to three year perspective and one need not worry about the day-to-day market movements. Happy investing!