Join our community of smart investors

Value investing pays if you've the patience and stomach

Nigel Waller and Andrew Goodwin explain why value investing pays if you're patient and have a strong stomach
March 9, 2017

The key to value investing is to buy shares at a discount to what you believe is the intrinsic worth of a company, ideally investing at the very lowest point of market sentiment, so the potential upside on your investment is as high as possible. This is the view of Nigel Waller, chief investment officer and portfolio manager at Oldfield Partners, which believes that what you pay for a share - rather than that share's growth - is the biggest driver of future returns. "If you buy shares at a cheap value, you will make money," Mr Waller asserts.

However, this can require a strong stomach. "There are really long periods when value doesn't outperform," explains Andrew Goodwin, portfolio manager at Oldfield Partners.

The past eight years, in which the market has been ruled by quantitative easing and low interest rates, has been one of them. The last time value was so out of favour was during the dot.com boom of the late 1990s and early 2000s.

And there are echoes of that today in the valuations of the so-called FANG technology stocks - Facebook (FB:NSQ), Amazon (AMZN:NSQ), Netflix (NFLX:NSQ) and Google (GOOGL:NSQ), he adds. But with interest rates rising in the US, Mr Goodwin and his colleagues believe that value is "coming back in a big way", and say that this has been reflected in the performance of their funds over one year. Overstone Global Equity Fund (IE00B0LLH114), for example, delivered 44.6 per cent compared with 28.3 per cent for MSCI World Index over this period.

Oldfield Partners runs concentrated portfolios, typically holding only 20 stocks in its funds. Mr Waller says focusing on its 20 best ideas makes sense. "You want to make sure you get some diversification, but by the time you're getting to your 40th best idea, how much is that really adding?"

Oldfield also believes that markets do eventually revert to the mean, but that you need to be patient. As a result, the firm tends to hold investments on average for at least three years, which the managers argue is a lot longer than many other funds do. The stock they have held the longest is Microsoft (MSFT:NSQ), which the firm held in its funds for 11 years until the start of 2016, and which returned 156 per cent during that time.

They eventually sold out of Microsoft when it hit their target price - which is when they tend to sell a holding. Their other main reason for selling is if a stock's value potential does not materialise.

"Value traps are the occupational hazard of the value manager," says Mr Waller. "We say 60 per cent of the time we are right. But when things go wrong, you have to grasp the nettle."

An example of a holding that went 'wrong' is US retailer Staples (SPLS:NSQ), which was sold last year after the US Federal Trade Commission blocked a $6.3bn (£5.15bn) merger between it and Office Depot (ODP:NSQ). Oldfield bought Staples because it was cheap and had lots of cash flow, and believed its management would implement a "slash and burn" strategy. But after the merger fell through the response from management was weak, Mr Waller argues.

Oldfield also takes a bottom-up approach, valuing companies on their individual attributes, meaning sector and country weightings are side-effects of their stock selection. Financials are Overstone Global Equity Fund's largest sector exposure, followed by materials, and Mr Waller and his colleagues believe could have further to run. One of Overstone Global Equity Fund's holdings is multinational banking and financial services corporation Citigroup (C:NYQ), which the managers believe is on a significant discount to tangible book value. "The group is delivering steady growth in revenues, and improving capital allocation and efficiency ratios," he explains.

Another area in which they are finding value is Japan, the fund's largest geographic exposure at 34.9 per cent of assets, and two of the fund's top five holdings are listed in Japan - Nomura (8604:TYO) and Mitsubishi UFJ Financial Group (8306:TYO).

Mr Waller says: "There is a lot of value in Japan. People see the headlines of deflation and an ageing population and so steer clear of it, but we often only get interested in an area when there are lots of negative headlines."

 

A broad church

Value investing falls into a broader church of investment styles than is generally recognised, which include distressed value, deep value and relative value. The difference between deep value, value and relative value is blurred as it depends on the valuation metrics you use and how out of favour the stocks are. "A simple way to think of it is that at a distressed level, 95 per cent of investors would think you were crazy for buying in," explains Mr Goodwin. "With relative value, only 50 per cent would think you were crazy.

"But investing is not a science because prices are determined by human beings, and with that comes the full tyranny of human emotions, the most overarching ones being fear and greed. What we are trying to do as value investors is to buy at a discount to fair value. So the way to do this, as [renowned investor] Warren Buffett would say, is to be fearful when others are greedy and greedy when others are fearful."

 

Andrew Goodwin and Nigel Waller CVs

Andrew Goodwin is partner and portfolio manager at Oldfield Partners, where he has worked since March 2013. This followed seven years at SVG Capital in London mainly managing European equity portfolios. Before this, he managed portfolios at companies including Sovereign Asset Management, American Express Asset Management and Phillips and Drew.

Nigel Waller is chief investment officer at Oldfield Partners, of which he is a founding partner. He spent the previous 13 years at MLIM where he was director and portfolio manager on the global team. During his time at MLIM he also worked within the emerging markets and European teams in London and, between 1997 and 1999, the Asia team in Singapore.