Value stocks are well represented in my portfolio. I don’t tend to go chasing after growth, instead I look for stocks that trade at a discount versus their book or intrinsic value.
That’s essentially what a value investing strategy is all about. As investors, we want to find stocks that are meaningfully undervalued and hold them until they’re trading at an appropriate valuation.
This can take time. After all, value investors such as Warren Buffett often take a very long investing position — it may take decades.
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So why invest in value stocks now? Let’s take a close look.
Falling share prices
A correction is a drop of at least 10% in the price of a stock, bond, commodity, or index. The market has fallen around 7% over the past month, but some parts of the market, such as finance, have fallen further.
Stocks like Barclays fell as much as 21% over the course of a month following the Silicon Valley Bank fiasco. This was followed by broader concerns about the health of the financial sector and, specifically, around billions in unrealised bond losses.
Under normal circumstances, the vast majority of bonds held by a typical bank — and their gains or losses — aren’t counted against earnings and regulatory capital until the bonds are sold.
The thing is, bond prices and interest rates move in opposite directions. Over the last year, central banks have pushed interest rates up considerably. That caused massive unrealised losses in the bond market.
But, for me and many analysts, the fear that banks are sitting on billions of losses has been overdone. After all, these are unrealised losses and big banks have more diverse holdings that SVB. Moreover, the big question is about the health of bank deposits. And I don’t see much stress here — although I appreciate some analysts do.
Europe’s banks are undoubtedly in a stronger position than during the financial crisis. For example, in the EU, bad loans have fallen from €1tn eight years ago to below €350bn last year — that’s only 2% of total loans.
Finding value
Investing in undervalued stocks is an integral part of the value investing strategy. However, the issue is finding these value stocks. It requires plenty of research because we’re essentially looking for value where others can’t see it.
I can look at simple, near-term metrics like the price-to-earnings (P/E) ratio, or enterprise value-to-EBITDA. That should give me a good idea of relative valuations.
But there are the more complex metrics, such as the discounted cash flow (DCF) model. This can be a difficult calculation as it requires us to make forecasts about future earnings over the next 10 years.
Buffett is known to look for a margin of safety around 30%, or even higher.
So as a value investor and with bank shares falling, I’m looking at this sector to invest in undervalued stocks.
DCF metrics suggest Lloyds could undervalued by as much as 60% and it currently trades with a P/E ratio of just 6.3. That’s why I’m looking to buy more for my portfolio.
But it’s worth noting that valuations across the financial sector, especially in the UK, look pretty attractive right now. Dividend yields have also pushed upwards as share prices have fallen.
