Many veteran fund managers, and some who manage the funds in the Scripbox portfolio, are practitioners of the principles of Value Investing.
Value Investing is the process by which an investor buys into a stock at a price that is reasonably lower than itsintrinsic value, with the assumption that the gap will reduce.
Assume that the intrinsic value of a stock is 100, and the current stock price is 70. The value investor buys the stock now, with the belief that the stock price will converge towards its intrinsic value over time.
How is Value Investing different in India?
Determining the intrinsic value is a complex question and on which various tomes have been written. However, there are a few other factors, unique to India, to take into account before one chooses to make a value investment.
- Intrinsic value and the discount to intrinsic value at which the stock is currently traded
- Expected time for the stock price to converge to its intrinsic value
- Will intrinsic value grow during this time
- Inflation rate and opportunity cost of investing in the markets
Let me illustrate this with the following scenarios:
Scenario 1 : The company has an intrinsic value of 100, and the current stock price is say 40. But intrinsic value is falling at about 10% per annum. This may sound absurd, but one sees such situations very often, mostly in hindsight. (MTNL had a net worth of about Rs 10,000 cr in FY2004, cash balance of nearly Rs 5,000 cr, annual profit of over Rs 1000 cr and a market cap of about Rs 10,000 cr. Eight years later, its market cap is down 85%, large losses and net worth has fallen sharply.) Such investments have a very short time period for value realization. Else, the investor is better off giving the investment a skip.
Scenario 2 : The company has an intrinsic value of 100, the current stock price is close to say 60 and intrinsic value is growing at about 5%. The upside from 60 to 100 looks great, but for each year of delay in realizing value, the investor loses about 3% against inflation. More importantly, the market’s intrinsic value is growing at close to the nominal GDP growth rate of 15%, and the investor loses 10% each year (15% market intrinsic value growth less 5% growth in intrinsic value of the stock) from an opportunity cost basis. I have seen stocks where the value realization has taken 5 years, and in the mean time, though the investor made a return ahead of inflation, has lost out on an opportunity cost basis.
Scenario 3 : Intrinsic value of 100, stock price is about 75 and intrinsic value is growing at about 10%. The value growth is ahead of inflation, but less than market growth. Such situations are much safer than the above two scenarios, where the investor who aims for absolute return will definitely make a return ahead of inflation. The investor is also getting paid for each year of wait to get value realized. On the other hand, not enough on an opportunity cost basis.
Scenario 4 : Intrinsic value of 100, stock price is about 85 and intrinsic value is growing at about 18%. The good thing in such situations is that the company’s intrinsic value is growing above nominal GDP growth and the market wideintrinsic value growth. The investor gets to participate in the intrinsic value growth, and at the same time benefit from the market price discount to intrinsic value. On the other hand, such stocks would rarely be available at valuation that looks cheap on an absolute basis.
The above variations in value investing are not that relevant in many developed markets where the nominal GDP growth and inflation are low. Whereas in India, with a reasonably high nominal GDP growth and inflation, analysing your value investing opportunity in this framework can have a reasonable impact on your decision itself.
If Ben Graham had lived in India when he discovered the principles of value investing, his 50 cents to the Dollar story may just read a bit different.