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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
THE NETHERLANDS
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. ■
INTERNATIONAL INVESTOR
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