Value Factor - The Complete Guide

• Date : June 14,2023

About Value Factor Investing 

When there is a sale at a store, shoppers rush to grab discounted items that are still high-quality and useful. Similarly, in the stock market, the value factor searches for undervalued stocks that are still fundamentally strong and have growth potential. 

The basic premise of value factor investing is to find stocks that are trading at a price lower than their intrinsic value, and will eventually increase in price as the market recognizes their true worth, hence increasing the tendency to outperform the benchmark. This strategy is an efficient way to “buy low and sell high”.
 

How is value measured?

To find the intrinsic value of a company, a discounted cash flow model can be used. However, it involves predicting future cash flows for the company which entails subjectivity. The future is inherently uncertain, and unexpected events can significantly impact a company's future cash flows, making accurate forecasting difficult.

To overcome this, many researchers and practitioners have focused on the quantitative aspects of value investing, particularly the calculation of earnings per share (EPS) and other ratios such as price-to-earnings (P/E), price-to-book (P/B), price-to-sales (P/S), price-to-cash flow (P/CF), enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA), and dividend yield. 

These ratios have been used to derive mathematical models for estimating a company's intrinsic value and identifying potentially undervalued stocks. These models have become widely used across the world as the predominant way of measuring value.

"Value investing is the art of buying stocks that are undervalued by the market and holding them until their true value is recognized." - Benjamin Graham
 

Buy Low and Sell High

Buy low and sell high is a very popular investment philosophy, however, it is easier said than done for individual investors. Timing the market and biases can lead to imperfection or mistakes in determining whether a stock is overvalued or undervalued. On the other hand, the value factors assesses stocks using fundamental metrics to determine whether these should be included in a value portfolio hence, making it an efficient way of determining the undervaluation of equities. 

For instance, assume a share currently trading at Rs 100, however, the fundamental value of the same share is Rs 130. Thus, at a future date, when the market realises the real value of the share, i.e. Rs 130 the investor would make a profit of Rs 30.

"Value investing is about buying a dollar for fifty cents, and waiting patiently for the market to realize its mistake." - Seth Klarman
 

Past Performance

NJ’s Factor Book data suggests that the 5-year and 10-year rolling returns of the NJ value factor portfolio are 12.93% and 12.34% respectively, in contrast to the benchmark Nifty 500 TRI return of 14.47% and 13.42% respectively. 

• Source: Internal research, Bloomberg, CMIE, National Stock Exchange of India 
• CAGRs are calculated as the average CAGR based on the rolling CAGRs (rolled daily) calculated for the respective holding periods i.e. 5, and 10-Yr rolling CAGRs. 
• The period for calculation is 30th  September 2002 to 31st December 2022. Data scaled to 1000 on 30th September 2002. 
• Past performance may or may not be sustained in the future and is not an indication of future return. 
• The above is only for illustration purposes. Past performance may or may not be sustained in the future. NJ Value 100 is a proprietary model developed by NJ Asset Management Private Limited. The methodology will keep evolving with new insights based on ongoing research and will be updated accordingly from time to time. 

In India, the value factor investing strategy has underperformed compared to the broader market for more than a decade with some resurgence in 2020 and 2021. One of the biggest challenges in implementing the strategy is the existence of perpetual value companies in both the public and private sectors, which have attractive valuations but their stock prices have stagnated. These companies are considered value "traps" and tend to be included at the highest end of most value definitions, which negatively impacts the performance of the value factor in India.

Despite the challenges, the value factor investing strategy has a low correlation with momentum and other factors, which can offer potential diversification benefits, particularly during periods of factor cyclicality. 
 

Value factor success overseas

MSCI terms the value factor as ‘pro-cyclical’ due to its ability to benefit during periods of economic expansion. The methodology of measuring value differs among different asset managers across the world due to the subjectivity involved. The 5-year and 10-year rolling returns of S&P Value Index are 9.48% and 8.93% respectively as compared to the 5-year and 10-year rolling returns of S&P 500 of 8.09% and 7.68% respectively. 

Source: S&P Dow Jones Indices LLC

• CAGRs are calculated as the average CAGR based on the rolling CAGRs (rolled daily) calculated for the respective holding periods i.e. 5, and 10-Yr rolling CAGRs. 
• The period for calculation is 5th July 1995 to 31st December 2022. Data scaled to 1000 on 5 July 1995. 
• Past performance may or may not be sustained in the future and is not an indication of future return. 
   

Conclusion:

To conclude, value factor investing is a strategy that involves identifying stocks that are undervalued based on fundamental metrics. The idea is to invest in companies with higher intrinsic value than the market value. Value factor investing is a long-term strategy that requires patience and discipline. Since it is not correlated with other factors, value investing can provide great benefits of diversification. 

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.