Curated Portfolio | XC Quant: Valuation
By Aashutosh Chandra (aashutosh.chandra@xumitcapital.com)
The Philosophy of Value Investing
The beginnings of value investing may be traced back to studies conducted by Benjamin Graham during the 1920s. Many of the concepts of value investing are covered in the book “The Intelligent Investor.” Value investing is based on the idea that when you buy stock of a company, you’re buying a piece of the company. While this may seem self-evident, many investors “play the market” without considering the fundamentals of the companies they buy.
The investor, like a business owner, should review the financial accounts of enterprises to determine their inherent values. Fundamental analysis is the term for this form of evaluation. The intrinsic value of a stock is almost never a single number. Rather, intrinsic value is generally a range due to the many assumptions that go into assessing a complicated organization. An investor should not be concerned about the lack of clarity.
Advantages of Value Investing
Good Stocks at lower price
This is one of the most significant advantages of value investing. The method aids in the identification of equities with high potential but are now trading at a discount to their intrinsic value. Investing in undervalued stocks on the stock exchange now, will help you earn greater returns in the future. Investing in value stocks might offer an investor with a margin of safety. The margin of safety is the difference between the stock’s intrinsic value and its current market price.
Factual Investing
Analysts choose value stocks based on a thorough examination of the company’s fundamentals. The strategy advises conducting a thorough investigation of the company as well as its future potential. Investing based on solid study and facts, rather than speculating, is a better strategy.
Does Value Investing work in Indian market conditions?
To understand the crux of value investing in India, we have taken the standardized value index created by the National Stock Exchange in India i.e. NIFTY500 Value 50 Index.
The NIFTY500 Value 50 Index is made up of 50 ‘value’ stocks from the NIFTY 500 universe that are currently trading at lower price multiples and paying a high dividend yield. The criteria used to find these value companies are supported by solid value investing theories as well as thorough back testing.
Observations
It can be observed that the NIFTY500 Value 50 Index has underperformed the benchmark in all the market conditions. It has been more volatile with lesser returns and more drawdowns than the NIFTY 500 Index.
This shows that relying solely on value metrics can be misleading and may reduce returns with greater risk.
However, if one still wishes to add value metrics to his/her portfolio then he/she can add other key factors such as profitability, growth, momentum, etc.
Introducing XC Quant: Valuation
Strategies based on multiple factors are a long-held notion of diversification, which states that mixing exposures to different drivers of returns (also known as factors) can help mitigate the impact of drawdowns while also increasing the potential for outperformance.
Multifactor strategies are based on the long-held notion of diversification, which states that mixing exposures to different drivers of returns (also known as factors) can help mitigate the impact of drawdowns while also increasing the potential for outperformance.
Using key valuation metrics along with other factors will not only help to create well diversified portfolios but also to minimize risk and maximize returns.
Below is the custom XC Quant: Valuation performance against the NIFTY500 Value 50 Index.
Summary
The average excess return is the portfolio return minus the benchmark returns. The top quintile of the strategy outperforms by a gap of 25% on average when compared to the Benchmark and does so for 73% of 1-year period.
Sharpe ratio which is the risk adjusted return which is greater than 1.76 for the portfolio is higher than benchmark i.e. 0.85.
It can be observed that the XC Quant: Valuation has clearly outperformed the NIFTY500 Value 50 benchmark and NIFTY 500 in all the market conditions. It has been less volatile with greater returns and lesser drawdowns than the benchmark.
This shows that combining value with other key factors can maximize the chances of greater returns with lesser deviation based on the above empirical study.
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