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    value investing

    Value Pays in 2022

    After a hiatus on the sidelines for over 10 years,  the Value swing has well and truly begun.

    Inflation and higher interest rate concerns, tech sell off, rise of the dividend and the search for unloved gems are now back on the agenda for the market.

     So what do we mean by value style investing? You can find a definition here but really it’s all about a philosophy of investing in companies that are unloved, overlooked and possibly undervalued by the market with the expectation that the market re rates their prospects and surges their prices higher.

    The characteristics of value style companies include low price to earnings ratios, higher dividend payout ratios and generally conservative balance sheets (low debt and good cash flows). Portfolios comprising these style of companies are called value style funds.

    So why is 2022 different for value style companies?

    There are a 3 notable reasons why value style investing is here to stay in 2022:

    • Rising rates and a reflationary environment

    Rising rates and an inflationary environment are  bad for growth style companies as their highly leveraged (aka highly indebted) balance sheets become expensive to service and considering many of these companies have questionable cash flow strength, investors start to wonder if there is too much risk associated with investing here.

    On the other hand, rising rates and an inflationary environment good for value companies because of their already low debt and strong balance sheets. Value companies can leverage into these times to capitalise on their strong cashflows and balance sheets to take advantage of expansion or M&A opportunities that may present themselves. Investors perceived that value style companies will provide greater risk adjusted returns over these economic scenarios.

    • Fall of tech and the rise of cyclicals 

    Fuelled by the pandemic, Tech stocks have been on the rise and rise for a while now. However these previous market darlings are now sighting issues with labour shortages, high costs and interruption of supply chains, resulting in margins coming under pressure. Their love of debt in an environment where interest rates are going up and their limited cashflows are exacerbating the current situation. A number of tech companies are off their highs by over 50%.

    On the flip side, cyclical companies (those companies highly leveraged to the economy) such as mining/resource, companies  , agriculture and consumer discretionary sectors, will do well in a rising rate environment. Cyclical companies can traditionally be seen as  falling into the value style segment.

    It is this transition between a sell out of Tech and a pile into cyclicals, that will support the value investor.

    •  Weight of Money

    Because investors have tended to put large amounts of money towards high growth companies in the past 10 years (and rightly so given the environment), this has meant that major investment portfolios have been letting their allocation towards value style equities wane. Now that sophisticated investors are seeing that value style companies are back in the limelight, they are beginning to re allocate to value style companies. It is this reallocation and the weight of money behind it that will further support companies in the value segment of the market.

    What are the risks with Value investing?

    Value style investing comes with one major risk which is called the “value trap” – companies can be out of favour and unloved for a reason. Determining what is company is a value trap and which companies can re-rate is difficult to make. It may be worth seeking to partner with investment professionals that analyse these companies day in day out and are discerning about this risk.

     How can you take advantage of value investing with eInvest active ETFs?

    eInvest’s ASX:EIGA portfolio has a value style bias and we have welcomed good capital growth and strong dividend growth, leveraging into this turn in market sentiment. You can find out more about EIGA here.

     

    Disclaimer: Please note that these are the views of the author Camilla Love, Managing Director of eInvest and is not financial advice. Past performance is not a reliable indicator of future performance. To find out how to invest in our active ETFs, visit here. The product disclosure statement, target market determination and more can be found at www.einvest.com.au.