Value investing

How can you retire in style?  Assess how much you spend now, and project how far into the future you need to compound that number by.

How would this goal be achieved?  Through investment.

To beat inflation and make money grow, many of us go for so-called growth investments, putting our debts on rapidly rising equities. Compared to bonds or bills, stocks are supposedly the fastest way to increase investment—that is, until the risks outweigh the benefits.

Instead of growth investing, many fund managers, including the legendary Warren Buffet, opt for value investing instead.

Note:  I am not a financial analyst.  For professional advice on investing, consult licensed practitioners.

The idea of value investing was coined by Benjamin Graham and David Dodd almost a century ago. Though methods differ, the principle is simple: invest in securities that are underpriced in some way—stocks with discounted book value, low price-earnings ratios, or high dividends—and wait for the market to adjust.

“Value investing basically entails picking up bargains in stock markets and holding on to them until prices rebound,” reports The Business Times, describing the recommendations given by Eric Kong, executive director of Singapore-based Aggregate Asset Management, during a recent seminar.

“One way to find such bargains is to divide the share price of a particular firm against its book value per share: a ‘bargain firm’ would be priced lower than the book value of the assets—such as cash, property and inventory,” Kong adds.

“In contrast, an ‘expensive counter’ trades several times above the net asset value.”

Data from the US through the various periods of boom and bust show value investing regularly outperforms growth investments.

However, critics say that sometimes when you buy shares in a bear market hoping for them to rise, the opposite might happen: the market is truly sluggish, and your potential value investment sinks even lower.

Often, too, when you are reluctant to buy shares because you think they are overvalued, their prices can still go higher, making you miss a chance to increase your investments.

What to do then? Diversify. Refrain from putting all your hopes into one or two investments: a mutual fund based on value investing may be your best bet.

Not surprisingly, Aggregate says it has investments in more than 500 counters, minimizing exposure, and thus risk, to each single stock to at most 0.2 percent.

Kong adds the fund “has returned a compounded 8.5 percentage points a year, and has outperformed the MSCI Asia Pacific All Countries All Caps Index by 6.1 percent on an annualized basis.”

Value investing, however, still has a major drawback. Sometimes, low prices mean just that—the company is not underpriced, but simply weak. How can we differentiate between the two scenarios?

Look at the F-score created by Stanford accounting professor Joseph Piotrowski. This score, from 0 to 9, is based on criteria which determine the soundness (or lack thereof) of stocks, which include: positive return on assets and operating cash flow this year; higher return on assets (ROA); gross margin and asset turnover ratio this year versus last; operating cash flow greater than ROA; lower ratio of long term-debt and higher current ratio this year than last; and no new shares issued this year.

The F-score was reportedly the only one among more than 50 screening procedures that gave a positive return during the 2008 US financial crisis.

For details on companies’ F-scores, visit the American Association of Individual Investors (AAII) at www.aaii.com.

Queena N. Lee-Chua is on the board of directors of the Ateneo de Manila’s Family Business Development Center.  Get her book “Successful Family Businesses” from the University Press (e-mail [email protected]).  Contact the author at [email protected].