The classic investing strategy you can't afford to ignore
Value investing has been the poor cousin of growth investing for half a decade, but don't count it out just yet. Warren Buffet is still alive and kicking, and so is his investing style.
Value investing is all about finding bargains. Like most markets, the stockmarket prices stocks based on supply and demand. But this price may be below what investment experts work out to be a 'fair price.
The idea is that the stock is then bought on the cheap, and eventually the market will realise it's actually worth more than it is and recalibrate the price upwards, thereby returning a profit for the said value investor.
Growth investing, on the other hand, is all about finding stocks that will grow faster than the rest of the market. The American FAANG (Facebook, Amazon, Apple, Netflix and Alphabet) stocks typify what growth stocks are all about.
Growth investing has had the upper hand on value investing over recent years. The MSCI Australia Growth Index shows an annualised five-year return of 10.52% compared to the MSCI Australia Value Index which shows an annualised five-year return of 8.55%.
This disparity has come amid low growth, cheap money thanks to low rates, lots of it thanks to central bank quantitative easing, and low inflation.
These kinds of conditions favour companies that borrow a lot of capital and reinvest it an eye to future earnings growth, namely big tech stocks.
"Pre-COVID, investors looking for growth were pushed into tech stocks and growth end of the market, and the low interest rates allowed them to pay whatever they liked," says director of portfolio management at Perennial Value Management Stephen Bruce.
But eventually, conditions change, and this could work in the favour of value investing.
"You're seeing a paradigm shift. You've had low growth, low rates, but now you see broader growth, rising rates and rising inflation."
Generally speaking, improving economic conditions are a good thing for all companies, even growth companies.
"As people look around and see there are other opportunities available, you get a grinding down of this valuation premium high growth companies have enjoyed."
One common misconception is that stocks with low price-to-earnings (P/E) ratios offer value, while high P/E ratios represent growth stocks.
"Simply buying the cheapest stocks isn't the way forward."
Indeed, you can have cheap stocks that are still overpriced, and expensive stocks that are still good value. So what assets and sectors stand to benefit from a rotation to value?
Among the sectors Bruce expects will benefit from an inflationary period of broad-based growth include commodities and consumer-facing cyclical stocks.
"Financials should also continue to perform well with steepening yield curves, and dividends will be bouncing back."