The two primary approaches to stock investing are Growth and Value. Most investment professionals identify with one of these approaches. Investment funds and their portfolio managers are labeled as growth or value. A core approach can use both methods to select investment securities. D’Arcy Capital is a value manager. Value investing is the best approach for achieving the returns investors require for their financial goals. Historically, value investing has outperformed growth investing over long periods. Over the last 20 years the Russell Large Cap Value Index returned an average annual return of 8.02% while the Russell 1000 Large Cap Growth Index returned an average annual return of 7.01%.
Value investing is divided into three sub-categories:
- Relative Value – Relative value is the least constrictive definition of value investing. It only requires that a stock provide a better value than similar stock. There is very little use of absolute quantitative measures such as price-to-earnings or price-to-book ratios in making relative valuations. If a stock has a price-to-earnings ratio of 30 times but the average price-to-earnings of the stock’s peer group is 32 times, it can be described as having relative value. The lack of consistent measurements for a relative value approach creates excess risk. An undisciplined manager can almost always make a case for any stock based on relative valuation. For most investors the vagueness of relative value makes it difficult to judge the overall performance of the fund or fund manager.
- Fundamental Value – Fundamental value (or traditional value) is the standard approach to value investing. It requires that potential investments meet certain pre-determined criteria before being purchased. These often include having low price-to-earnings ratios, low price-to-book ratios, and a requirement that the stock return earnings back to investors in the form of dividends or share buybacks. Fundamental value managers seek temporarily underpriced stocks that will return to historic price levels. The low price-to-book requirement is critical because it can provide a “hard floor” to protect from further downside. Dividends are also important because they can still compensate the investor while waiting for the stock to appreciate.
- Deep Value – Deep value investing is also known as contrarian investing or in specific circumstances vulture investing. Deep value generally follows very strict requirements for very low price-to-book valuations. In many cases deep value investors require that the break-up value (selling all individuals assets of the company) is higher than the current stock price. This allows the investor to reap a return even if the stock price does not recover. Deep value investors typically select companies that are experiencing extremely hard times. Deep value investing can produce major returns but carries increased risk as some investments will completely fail.
Why is value investing better than growth investing?
- Value investing is best for most investors because of the high net asset values (low price-to-book), the dividend requirement, and a disciplined framework to choosing securities.
- Although finding a stock that is trading at a discount to its net value is not easy, it is possible and provides a “floor” that does not exist for growth investors.
- Because value stocks often pay a portion of earnings back to investors in the form of dividends, the duration of the stock is lower than growth stocks. This means there is less volatility because investors are receiving some of the overall return every quarter instead of waiting until the stock is sold.
- Using a defined investment selection process will produce a system that is not subject to emotional trading.
D’Arcy Capital is committed to value investing. D’Arcy Capital takes an active approach to fundamental investing and is not constrained by benchmark allocation weightings. In short – D’Arcy Capital invests where their analytics takes them. The firm identifies with a bottom-up approach and uses additional proprietary metrics and modeling to find temporarily undervalued companies. The firm can choose from a global universe of stocks. All research and investment decisions are conducted using “in-house” research.