Value Investing

Charles Dalziell CFA

What is It?

“The strategy of selecting stocks that trade for less than their intrinsic values. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.”

Source: Investopedia

Investing vs. Speculating

Investing in stocks means only buying shares when you have a thorough understanding of the underlying business fundamentals of the company, as well as a sound basis for determining that stock’s value.

Speculating is buying stocks without this knowledge

Macquarie Research - Style IndicesValue vs. Growth

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

Value Growth

Source: Macquarie Research

Why does Value Work? Much of the downside is already priced in

Value often gets free options on upside surprise

Bird in the hand theory

Negative sentiment doesn’t last forever

Value avoids paying for high expectations

Growth stocks get punished more than value stocks if they

fail to deliver

The market is generally short-term in focus

Signs of ValueBut not a guarantee

Low price/earnings ratio (PER)

Low price/cash flow ratio (PCF)

Low price/book value (PBV)

High dividend yield

Low price/NPV

Solid balance sheet

Typical Characteristics of Value Stocks Out of favour with the market

Share price has been weak or has

underperformed

Problems are temporary or fixable

The underlying business is well placed

Demonstrating attractive value criteria

Changing management

Typical Characteristics of Value Investors Disciplined Patient Contrarian Courageous Thorough Focused Self belief Conservative Thinks like an owner

Value Process Screen for Ideas Focus on your circle of competence Study the competitive landscape Evaluate the management Understand the financials Is the business a good one? Value the stock Is the stock cheap? Why? Act on your idea Don’t be too clever

Valuation ModelsArt Rather than a Science

Price/Earnings Ratio (PER) Price/Cash Flow EV/EBIT EV/EBITDA Discounted cash flow Price/Book Total Rate of Return (TRR)

Most important inputs to models are Growth Rates and the Multiple or Discount Rate

Typical Characteristics of a Good Business Solid track record High ROIC High margins Dominant market share Low cost producer Pricing power Brand recognition Capable management Minimal Government regulation

Good Business vs. Good Stock

A company can have a great business but be a poor investment if you pay too much

Every business has a value. Some are more easily calculated than others.

Every company has been or will be a value stock at some stage

CSL Limited

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

Source: IRESS

CSL LimitedMBA PER Relative to S&P/ASX 300

0.6

1.0

1.4

1.8

2.2

2.6

2002

2003

2004

2005

2006

2007

2008

2009

2010

(X)

Historical PER Relative MBA - 5 year average Broker - 5 year average

Source: IRESS, MBA

Misconceptions about Value Investing Value Investing is a myth

No consideration is given to growth

No emphasis is given to quality

Stocks must have low PERs

Great businesses are never good value

Value investing is cigar butt investing

Shortcomings of Value Investing

Value traps

Buying too early

Selling too early

Underperforming for long periods

Telstra Corporation LimitedValue Trap?

$2

$3

$4

$5

$6

$7

$8

$9

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

Source: IRESS

2000 PER: ~28x

2010 PER: ~9x

Disclaimer

This presentation was prepared by Maple-Brown Abbott Limited (Maple-Brown Abbott) ABN 73 001 208 564, Australian Financial Service Licence No. (AFSL) 237296, is intended to provide general information only, and does not have regard to an investor’s investment objectives, financial situation or needs. The content does not constitute advice and should not be relied upon as such. Our presentation, including comments we make about individual stocks, is intended only to explain our approach to managing funds. In discussing individual stocks or other investments we do not make any recommendation or give any statement of opinion that is intended to influence anyone in making an investment decision. Investment advice should be sought in respect of individual circumstances.