The growth-fueled bull market may have had value investors scratching their heads wondering when their vaunted strategy would once again come to the fore. Enter the coronavirus pandemic and now value seems to be back in vogue, but investors should have a strategy in place.
“Value investing always involves buying companies with problems,” wrote market analyst Jack Forehand in The Globe and Mail. “It always involves dealing with the uncertainty that the future will look different than the past. Obviously that level of uncertainty can vary significantly over time and it is probably close to an all-time high right now. But at a high level, what we are dealing with is certainly not unprecedented. But having said that, I think there are some important things to keep in mind when building a value strategy in a time like this.”
Forehand identified these four key components to implement a value investing strategy, especially after the coronavirus pandemic:
- Make sure companies are a cash cow: Forehand noted that “value investing always has a high error rate, and many companies you buy as a value investor end up doing poorly. Some even don’t survive. But during a time like this, with many businesses completely or partially shut down, this is especially important. I think any analysis of value stocks right now should include a look at whether the company can survive.”
- Seek diversification: “When prices fall very quickly for industries like airlines or hotels or cruise lines, it is easy to think that the stocks within them are worthy of aggressive buying,” Forehand said. “That may end up being the case, but the problems in some of these industries and individual names may also end up being even worse than what is currently priced into the stocks. As a result, diversification takes on an added importance during a time like this.”
- Consider a company during times of normalcy: “Even though the vast majority of companies will have lower earnings and cash flows after an event like this, it is still important to consider a stock’s valuation relative to something that represents more normal times,” said Forehand.
- Use negative quality screens: Forehand cited that “most quantitative value firms use some sort of system to try to limit value traps. The criteria within these systems can vary, but what they have in common is they try to filter out names with obvious problems.”
Relative Play on Value
Will a mass movement away from growth into more quality, safe investments predicated on value be on the way in a post-coronavirus market? From a relative value ETF standpoint, this could put value over growth equities and defensive over cyclical equities in play—particularly, the Direxion Russell 1000 Value Over Growth ETF (NYSEArca: RWVG)
RWVG seeks investment results that track the Russell 1000® Value/Growth 150/50 Net Spread Index. The fund, under normal circumstances, invests at least 80% of its net assets in securities that comprise the Long Component of the index or shares of ETFs on the Long Component of the index.
The index measures the performance of a portfolio that has 150% long exposure to the Russell 1000® Value Index (the “Long Component”) and 50% short exposure to the Russell 1000® Growth Index (the “Short Component”). On a monthly basis, the Index will rebalance such that the weight of the Long Component is equal to 150% and the weight of the Short Component is equal to 50% of the Index value.
For more relative market trends, visit our Relative Value Channel.