• Stonewood AM



“Value” is a word that is bandied around in investment circles and contexts with almost as much frequency as the word “investment” itself. Made famous by the likes of Benjamin Graham and Warren Buffet, value investing is in itself a well-respected style of investing and recognized factor in the now popular factor pool.

“Valuation” on the other hand refers to the process of determining the value of something (an estimation of the worth of something).

The theory behind value investing is that assets can at times be cheaper than their true worth and if you buy assets at a discount to their fair/true value, you will over time likely benefit from the reversion to that theoretical value.

For instance if you determine via some method; the Discounted Cash Flow method (DCF) for example, that Apple shares should be worth $300 per share but are currently trading at $262 per share, then they are trading at below what you think their true value is. Assuming that you think the market and its participants have simply got it wrong; by pricing the shares $38 ($300 - $262) below their calculated worth, you should benefit from the fact that above-average possibility that the market realizes its mistake and attributes the true value of the share to your investment as more buyers bid up the price.

Value investing often leads to the investment in assets that are shunned or unloved by investors or the market as a whole and picking things up at a “bargain price”. There are of course assets that are cheap for a reason and the market has got it right in its assessed valuation but often we find that this is not the case.

As a style, it has become one of the most popular investment strategies in the world of investing. Although to some extent, people tend to naturally buy things that are appreciating in price and outperforming as opposed to those that are dropping in price or unloved. Often cited as one of the reasons that value as a style tends to command a return premium in the first place.

Valuation applies to the process as mentioned above. When investment specialists and advisors talk about markets, regions or asset classes as being overvalued, they are not referring to a specific investment style per se but are rather, as a rule, saying that they think on aggregate these assets are trading above their fair value.

This is a hot topic at the moment because almost all major asset classes (with specific reference to equities and bonds) are considered overvalued across almost all metrics. Again, by way of example the long-term valuation average of the S&P 500 (using the CAPE Shiller PE Ratio is currently around 30x in relation to the long-term historical average of 16.7x).

As seen above, what it means is that if we use history as some guide to what the fair value of US equity should be overall, then currently we would be overpaying significantly for the asset class.

US Equity, however, could be more “overvalued” than UK Equity. As UK Equity may be trading at a lower premium to long term average or even below the long-term average, making investing in UK Equity a better value style investment than US Equity. This is a relative valuation argument because you are comparing the valuation of two markets in relation to one another and not necessarily making the case that either of them is in fact by itself in value territory in relation to the valuation calculation being done.

All of which makes our understanding of the term’s “value” and “valuation” confusing, to say the least.

Value as a style has also underperformed other investment strategies for a long period of time because investors have favoured growth or momentum style assets. Which makes value as a style relatively undervalued overall. (The chart below shows that value as a style should outperform growth as a style by about 1% per annum over time but over the last 10-years has trailed growth by around 4% per annum!)

Source: Research Affiliated, Advisor Symposium Oct 2019

So how to make heads or tails of any of the above you may ask?

In truth, I wish I had a definitive answer to that question, but I think there are some take-aways for any investor to make use of when making investment decisions or listening to someone talk about value or valuation.

My take-aways from this are as follows:

  • Value is the price of something as determined by some method (some valuation process).

  • Value Investing is the pursuit of investments that are undervalued for some reason and therefore the theory is that they will “mean-revert” over time and the investor should profit as the market realizes the mistake it has made. (important side note is that this process can take a LONG time)

  • Valuation is the process of determining the price of something in order to make an investment decision or report back to investors.

  • Relative valuation is when you compare the price or “value” of one asset or asset class to another, for example:

o Apple can be more expensive than Nike but cheaper than Amazon on a valuation metric (Price to Earnings, Price to Book etc.)

o Stocks can be more expensive now than they've been on aggregate in the past

o A style of investing be undervalued relative to its long-term expectations

History has a habit of repeating itself and as a result (without making any prediction of any kind) it is likely that as a rule buying things at a discount to that items true value, either on a relative or absolute basis, is likely to yield a better outcome than if one were to buy it at a premium. The inversion of that is that as a rule, overpaying for something or buying it at a time that everyone else wants to buy it as well is likely to lead to a lesser outcome.

So, both value and valuation are important when making an investment decision of any kind even if you yourself are not following the value style of investing.




Source: FactSet, S&P

A myriad of economic updates was released locally and abroad in the month of October. All of which were not desirable nor optimistic for the foreseeable future. Equity markets were however upbeat with the JSE ALSI ending the month 3.1% higher, that’s a 10.4% rise year-to-date.

Resources led the ALSI higher with a 7.3% rise. Supply constraints on nickel and palladium saw prices of the two metals spike. Companies that produce these metals, like Anglo American Platinum surged more than 20% for the month. Mid-Caps and Financials added 7.2% and 3.6%, respectively.

The outlook on the South African economy has been tempered by unfavourable economic indicators, with unemployment in the third quarter of 2019 rising to 29.1% according to Stats SA. Finance Minister, Tito Mboweni presented the Medium-Term Budget Policy statement (MTBPS) last month which revealed the state of the fiscus, below a few of the main points:

  • Economic growth has been revised down from 1.5% to 0.5% for 2019

  • National debt is in excess of R3.0-trillion, projected to rise to R4.5-trillion in the next 3 years

  • We need to borrow an additional R52.5-billion to cover the 2019/20 revenue shortfall

Ratings agency Moody’s went on to change the outlook of the country’s credit rating from stable to negative, citing low potential growth and the rising debt highlighted in the MTBPS. SA Bonds were negatively affected, ending the month 0.3% lower. The rand closed 0.7% stronger against the US Dollar as a result of US weakness as opposed to ZAR strength.

Downward revisions of economic growth were not isolated to SA, with the International Monetary Fund (IMF) cutting the outlook for 2019 to 3.0% down from 3.2%. This is not uncommon as expectations are generally revised downward as we progress through the later parts of the year, this may be a result of over optimistic analysts at the commencement of every projection period.

Similar to the performance of the SA bourse, Global Equities rose 2.8% with Developed Markets adding 2.6%. Emerging market equities closed 4.2% higher. The price of Gold advanced 3.1%, contrary to the way markets usually react when equities rise.

The price of oil dropped 0.9% for month. In related news which has no bearing in the price of oil, one of the largest companies in the world in terms of revenue, Saudi Aramco, is poised for an IPO listing of between $1.2-trillion and $2.0-trillion. The company is the biggest energy company in the world, producing 12.5 million barrels per day.

Despite economies contracting and global growth slowing, investors continue to invest in equities as evidenced by the rise in counters across the board locally and abroad. See below a graphical representation of market performance, showing the asset class returns for October (in ZAR):

Source: FactSet

See below data showing how the average fund in the different ASISA categories performed in the month of October, indicative of the average South African investor:

Source: Morningstar. Returns longer than one year annualised

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