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What is value investing? Amit Premchandani of UTI AMC explains

A reason why a cheap multiple driven approach to 'Value" is not working is that, in fact, cheap valuation could be misleading.

October 24, 2021 / 08:29 AM IST
Representative Image

Representative Image


What is Value?

In common market parlance the term 'Value' has come to denote cheap valuations based on multiples such as low price to earnings or price to book rather than the concept of 'Intrinsic value'. For me, 'Value' is a reference to 'Intrinsic value' and there are many ways to derive intrinsic value. Intrinsic value was best described by Warren Buffet as - "the discounted value of the cash that can be taken out of a business during its remaining life".

As an investor, focus should be on buying businesses for less than its 'Intrinsic value'. Our core belief remains that the market has moved away from the approach of "cigar butt investing" which essentially meant buying a company at a significant discount to liquidation or replacement value or book value.

The kind of free lunches available in the age of information asymmetry are hardly available now, and in case something is really cheap as compared to its liquidation value or for sake of convenience its book value, generally that company is dealing with specific issues. These kinds of free lunches are now available only during times of significant market dislocations. Buying a bond at 80 percent of maturity value hoping for full repayment at maturity including coupons works well in debt investing but caps upside in equity investing. Applying such an approach essentially means buying stock at say 60-70 percent of book value and expecting that to move to 100 percent of book value, essentially selling off post it reaches 100 percent as not much "value" is left. This is a narrow interpretation of value and in many cases has led to significant erosion of principal as investors fail to account for capital requirement of such businesses or inability to monetize the resources which were part of their net assets.

A reason why a cheap multiple driven approach to 'Value" is not working is that, in fact, cheap valuation could be misleading. It does not take into account issues such as capital allocations, low terminal value, poor cash conversion/ free cash flow generation, excessive leverage, unrelated/ uneconomical diversifications, incentive misalignment, governance, treatment of minority shareholders etc. There is a high chance for few among this varied list of reasons to show-up often in cheap valuations. A reliance on only statistically cheap valuations that ignores these factors, perhaps result in poor investment outcomes.

Close

My approach to value investing as a philosophy is captured through following key pointers:

• Avoid companies with concerns over terminal value
• Accept premium for high ROCE (return on capital employed) over low ROCE companies
• Focus on Free cash flow yields as compared to PE (price-to-earnings) for relative valuations
• Multiple should be viewed in conjunction with governance or debt issues
• Appreciate ability of the company to manage working capital and ensure high conversion of EBITDA (earnings before interest, tax, depreciation and amortisation) to Operating cash flows
• Evaluate abilities of new age companies to scale with low incremental capital after achieving positive unit economics

• Take cognizance of embedded option value in companies which have invested in related ventures

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Amit Premchandani is the Senior Vice President & Fund Manager – Equity at UTI Mutual Fund. He has over 13 years of experience. Amit joined UTI AMC in 2009 as Senior Research Analyst and has covered Banks, NBFCs, telecom and cement in his research role. In addition, he took up portfolio responsibilities in June 2014.
first published: Oct 24, 2021 08:29 am

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