Value Investing for Economic Recessions

The “Monday Effect” is a well-known stock market anomalies that suggest certain cyclical and seasonal patterns in stock prices, potentially challenging the Random Walk Hypothesis, which posits that stock prices move unpredictably and independently of their past movements. Let’s explore this anomaly with some case studies and statistics:

The Monday Effect, was first reported by Frank Cross in 1973, suggesting that stock returns on Mondays are typically lower than other days of the week.

Case Studies and Statistics:

One of the most common terms used on social media to convince people buying investment courses, from universities or some other independent institutes. The father of value investing is “Benjamin Graham” and his most famous apprentice “Warren Buffet”.

If you have slight interest in the investment world, for your personal wealth or even professionally working in this space, to a great certainty you might have heard about the book “The Intelligent Investor” or even read it.

You might have also charted the decision-making processes and protocols from the book, for me personally the intelligent investor, is one of my favourite classicals.

After meeting with so many investors, managing quite a large portfolio of client assets, reading a lot of books and writing some of them myself, I wanted to share with you this brief article about value investing so you may form your own perspective on what “Value investing” really means.

Investor psychology

a lot has been written and actually I dedicated a whole chapter about it in “the cash cow , the trader who sold his cow”. The chapter is titled as “eve’s apple” and our easy psychology falling into out of balance and temptation to weak investment habits. The aim of smart investor is always to be patient or pay-tient and disciplined. We have developed in that book a list of tools that can help restore balance and articulate self-awareness tactics to maintain a disciplined investment/trading business.

As when it comes to value investors, they are looking on the long terms valuation of their assets, they need to avoid being swayed by short term market movements, and focus on the long term fundamentals of the company they are acquiring as well the essence of their strategy.

Undervalued or Overlooked

According to Mohamad Mrad a value investing strategy involves acquiring/buying stocks that are undervalued by the market. This comes from the concept that the markets are not always and that there are opportunities to buy stocks at bargain, at discount to their intrinsic value.

At this moment I would like to highlight the idea from the intelligent investor “buy your stocks like you buy your groceries, most people buy stocks like they buy their perfumes”.

Yet the challenge become how to find these stocks? Do you find them though an AI screener, or stockbroker, or what your friends say? Is there a way to figure out these stocks?

Let us proceed and check…

The aim is to find stocks that are trading at discounted price relative to its fundamental characteristics such as:

  • Their earnings
  • Dividends
  • Debts
  • P/E ratio (price to earnings ratio)

The common believe is that these stocks will eventually be recognized by the market and will outperform the overall market or growth stocks in the long run.

(Long run in classic finance is over 10 years period, isn’t this really long, in the current markets and hypes flips of today, people are looking for 2X on an average of 4 years period, i.e.: doubling the assets value every 3 to 4 years or faster); waiting to double the assets in 10 years is similar to investing in real estate in a mature market like the UK that is appreciating every year by 8% on value.

So, in today’s markets that time horizon must be reconsidered specially when the investor is looking for a value portfolio.

Remember the word value comes from the intrinsic value of the company.

“Low price – to – earnings ratio P/E”

This financial ratio measures the price of a stock relative to is earnings per share. This is calculated by dividing the current market price of a stock by its earning per share or (EPS). (PS: all these statistical data are available for every company you intend to invest in on yahoo finance and some other websites for free).

When looking for undervalued stocks the aim is to find a low P/E ratio company. Yet it is not enough on its own to approve a buy signal for a company. It is useful for comparing the different stocks in the same sector or industry. Another way of using it is also to compare the current p/e of the company with its historical values. However, on its own a p/e ratio is not enough to make a value investment decision. Other factors must be considered to complete the decision model:

Financial performance ratings to evaluate the earning, debts

Circulating vs non circulating shares (To avoid severe manipulation scenarios)

Industry trends

Economic cycles (four easy to recognize – recessions, recovering or rallying markets, boom, and slowdowns)

Putting all of these together help bring a more complete decision making model to optimize on the investment in terms of risk reward ratios and time horizons.

The Economic Cycle

It is imperative to know which phase of the cycle we are in. The global economic cycle can be read from the major stock almost 1 or 2 quarters in advance before the new starts mentioning it. Is price of major blue chips stocks leading in every sector start falling down and their trend changes in direction. Once the cycle is identified. one must start directing the portfolio toward the suitable sectors and most importantly these slow downs and recessions phase of the cycle presents great opportunities for smart investors to acquire their value investments in stocks in the relative sectors. For example when in recession the best value stocks are going to be in the Technology – consumer discretionary, Communications, Industrials and material sectors. While shifting from a Boom to a Slow-Down in economy the best sectors are going to be Energy – Commodities – Health Care and Utilities.

High dividend yield

Another ratio to valuate value companies for investment are the dividend yields and we typically are looking for high dividend yields. They indicate that a company is paying out a large portion of its earnings as dividends, which can be attractive to the income portfolios. It as well indicates the health of the company balance sheets as good prospect for the future run.

Balance sheet

All publicly traded companies must report their annual balance sheets. By now you must be familiar that every information you need about them is available for free on the yahoo finance. A strong balance sheet must indicate a low level of debt “financial gearing ratios”, a sound track record of earnings and cash flow. As these companies would stand much better chances to weather economic downturns and hence present a stable return over the long term.

Word Of Caution from Mohamad Mrad

With great caution, investors must mitigate their expectations of risk, reward and time horizons. As the market may take longer time to recognize the value of a stock, or the company’s fundamental may deteriorate. The key advantage is this strategy is the margin of safety against potential losses, when buying undervalued stocks, investors are able to minimize their downside risk and potentially realize higher returns. One of the most difficult challenges for value investing is how to accurately determine the intrinsic value of a company a careful assessment of the financial statement looking for the ratios and notions mentioned above is a must to make an informed judgement about it’s a true value.

Given all of the above, value investment requires a long term vision and as well it must be couple with some other strategies like growth investments to continually beat the market.

For that, read the article on predictive investments.