10 Nov 2017
By: Errol Shear, Fund Manager: Sasfin BCI Opportunity Equity Fund
As pragmatic value investors, our approach is to follow the investment style of the classical value investors. According to Investopedia’s definition of value investing, the style is derived from the great twentieth-century value investors such as Warren Buffett and Benjamin Graham. “…Like bargain hunters, the value investor searches for stocks that he or she believes are undervalued by the market, stocks that are valuable but not recognised as such by the majority of other buyers,” the definition says.
One of the characteristics of value stocks is that they tend to trade at higher yields than average. If you look at the average dividend yield of shares classified as value stocks on the JSE, they currently have an average dividend yield of 3.9%, or 1.7% more than the yield of the growth stocks. Value investing requires patience, but while you are waiting for value to be revealed, you are also enjoying a higher dividend yield.
A core tenet of value investing is to try avoid overpaying for stocks which are expensive because too many investors are following a trend and continue to pay higher and ever higher prices for a popular share. Momentum investors, however, will buy a share purely on the basis that because the share price went up yesterday, it should go up again today. By buying the popular shares, momentum investors will push these share prices even higher, thus creating a self-fulfilling situation, certainly in the short term, while in the meantime the share becomes more and more overpriced.
This is also the argument against index investing, where the more expensive a share becomes, the greater the weighting in the index. As a value investor, our philosophy is to seek out those shares which the stock market has ignored, not disregarded because they are bad companies, but ignored because they are not fashionable. Fashions change, remember when everyone had a Kodak Camera, or when Blackberry was the cool phone to use? Today these businesses, which once had massive market capitalisations, are either gone or a shadow of their former selves. Currently Apple is the iconic fashionable brand, but will Apple continue to turn out new products for many years which are in high demand and for which consumers are prepared to pay top dollar prices? Or will Apple go the same way as Kodak and Nokia. I don’t know the answer, but history teaches us that it is difficult for a company to always remain on top.
In South Africa we saw the construction companies soar in price ahead of the 2010 World Cup mini construction boom. This was always going to be a short-term boom, ending in 2010. Nevertheless, eager momentum investors pushed the price of Murray & Roberts up to over R100 per share and a price earnings ratio of over 30 ahead of the tournament. This was a fashionable area in which to invest. Many years later the Murray & Roberts share price has recovered, but only to R14. Similarly Aveng soared to over R60 and a price earnings ratio of almost 30, before falling to the current level of R4. Aveng has not paid a dividend for four years, so there was no great compensation for the capital loss from dividend yield.