The Merits of Value Investing by rlb27893


									                                                                                             THE NETHERLANDS

The Merits of Value Investing
"Market Inefficiencies are the Result of Human Behaviour"
Veer Palthe Voûte

■    Value investors look for invest-
     ments where the analysed value
is greater than the current market
                                          peculiarities of human behaviour.
                                          People are inclined to exaggerate,
                                          whether in a positive or a negative
                                                                                      A value investor must examine
                                                                                    things objectively, free from external
                                                                                    influences. This may be difficult, but
price. The definition is simple, but      sense. As the internet bubble             it is certainly possible. You need to
that is only the start of the discus-     expanded there were obvious signs of      keep your eye on the facts, and not be
sion: how exactly do you determine        massive overvaluation. Neverthe-          distracted by the latest big story to
the value of an investment? At Veer       less, many investors stuck with           hit the news. 9/11, Iraq, SARS: these
Palthe Voûte (VPV) in Gouda we look       certain shares.                           have all led to overreactions in the
for such opportunities in the market,       The opposite can also occur;            market. There is a good reason why
and we have had considerable              sometimes shares are undervalued          VPV portfolios showed the best
success in finding them. The average      for years. Nobody shows an interest,      returns in the aftermath of 9/11. The
return for clients over the last twelve   and all the time the business is          market dropped so fast that an
years has been approximately 18%.         growing apace. The task at hand for       imbalance between price and value
  Global political unrest, an economy     the value investor is to pick out         became inevitable. We bought, and
hesitating between recovery and           precisely those incorrectly valued        achieved an excellent annual return
recession, wild currency fluctuations:    shares. What you are looking for in       for our investors.
in turbulent times many economists        any undervalued business is a               Value investment flourishes in
and investors in particular are on the    catalyst, some trigger for the reversal   relatively turbulent times. We are
lookout for the slightest bit of news     of the undervaluation. It might be a      less inclined to outperform when the
that could indicate what "the             cost-cutting program, new manage-         entire market is running well and
market" might do next. VPV's Value        ment: something to indicate that          there are less opportunities at hand.
Investors take a different approach.      there is a likelihood of an improve-      When other investors are wary, we
By definition, a value investor           ment of the (low) valuation.              are alert, as we know from experi-
doesn't take any view of the market         The counterpart to value investing      ence that opportunities arise at such
as a whole.                               is the efficient market theory. This      times, with share prices following the
  Only individual investments are of      works on the assumption that all          market down. The price falls while
interest. The strength of this            available information is already          value stays steady or even rises.
approach at VPV lies in our selection     factored into all security prices.          An excellent exercise for the value
of shares whose price is temporarily      Practical     experience      however     investor is to reason out the share
lower than the underlying value, for      suggests the opposite. Take for           price in reverse. You take an annual
whatever reason. The current price        instance the Parmalat affair, a fairly    report and determine a price for the
is easily determined from the             recent example. The major account-        relevant share on the basis of the
market. Determining the intrinsic         ing scandal within that company led       facts. This can throw up some
value is the difficult part, and          investors to re-examine the debt          surprising results.
demands an ability to thoroughly          securities of numerous other Italian        One weakness of value investing
understand a business.                    companies, while in fact there was        is that at certain times there are
  The crucial question for value          nothing extraordinary about them.         no good opportunities, times when
investment is where and when does         The prices of the securities of other     everything is too expensive. If you
undervaluation arise. A value             companies were therefore dragged          stand by your principles (and that
investor making a judgement reaches       down in the chaos surrounding             is what you must do at such
a conclusion whether a share is           Parmalat. The value investor sees         times) you will put your money on
highly, fairly or cheaply priced. Such    such events as opportunities. These       deposit temporarily in the expec-
undervaluations, and indeed overval-      are temporary undervaluations,            tation of better times, meaning
uations, are always caused by             driven by human errors.                   "more opportunities".

                                                                                                   INTERNATIONAL INVESTOR

  One of the principles for VPV is to   practice and buy while the rest are      The major banks retain analysts who
invest only in companies with a         selling. You do need to keep in mind     must generate commission income
sound dividend policy. Value            that the shares you buy may              with their recommendations. In
investors assess companies on the       continue to fall for a while.            other words, deals need to be done.
basis of cashflow generation, and          Many investors will then doubt        This is not an issue for us. Further-
subsequently on their dividend          their judgement, but a value investor    more we think we are unable to add
policy. Value investors cannot          is less concerned about current shifts   much to the research on the largest,
assess a company without cash           in the market. If you have done your     most liquid, shares.
flow. When selecting a share our        research and stand by your share            One great advantage with the
method is to assess its valuation in    selection you needn't be too nervous     smaller shares is that the assess-
a historical context. We look at        if the shares drop a little further in   ment is simpler. It's easier to get the
others in the same sector and at the    the first few weeks or months after      full picture of a company with a
dividend returns, which we offset       the purchase. You have the comfort of    turnover in millions than it is if the
against the return on bonds. This       knowing that the underlying value of     figure is in the billions. There is also
produces the assessment.                the company is still higher than the     little competition from other
  People can be very persistent in      price you paid for the share. And you    analysts. The smaller companies
the mistakes they make, so you see      may even be able to buy at even          have a smaller following by defini-
the same opportunities coming up        lower prices.                            tion. Statistically it appears that the
during each cycle. And at times of         There is no particular pattern to     smaller shares can rise faster, and it
tragic events the markets can react     the companies we follow, at least not    is also an advantage for us that their
in a very primal way. An example        in the sense that we have a prefer-      managements can be more approach-
was the punishment handed out to        ence for certain sectors. However,       able. After all, talking to the
virtually every insurer following       unlike many other asset managers or      management will give you a better
9/11. In many cases this proved to be   banks we do follow some smaller          picture of the company than if you
a mistake. At such times you put        funds, companies that are so small       look solely at the figures in the
your value investor principles into     they fly below other people's radar.     annual report. ■


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