Globally, the value theme has underperformed growth over the past decade.
A ratio of the MSCI Value Index to the MSCI Growth index, which was around 1x in 2010 has halved to approximately 0.5x in 2020.
A key driver for the outperformance of growth over value has been the steady decline in interest rates over the past few years. In many countries interest rates are close to zero. This has reduced the cost of capital, resulting in a higher multiple for future earnings, which in turn has a positive impact on valuations of growth stocks as their earnings are typically back-ended.
Tech growth
Especially, post the downturn in March, growth stocks, mainly in the technology and healthcare sectors, have outperformed both globally and in India.
For example, in the US, the tech-heavy Nasdaq is at an all-time high.
Even in India, the healthcare and information technology sector indices have risen 30-45 per cent YTD (year to date).
The fact that these sectors have benefited from the Covid-19 pandemic, along with the decline in interest rates, has led to their re-rating. In contrast, value stocks in sectors such as financials, energy, industrials, materials and utilities have lagged, leading to a marked divergence in performance between growth and value stocks globally. However, value stocks have now started picking up as they are trading at an attractive discount to large-caps.
Going forward, the ‘pandemic trade’ will give way to ‘re-opening trade’ and the latter should benefit value stocks.
In addition, the fact that interest rates don’t have much room to fall further favours value stocks.
Hungry for yield
Lastly, in an environment of low interest rates, long-term investors such as pension funds and sovereign wealth funds are hungry for yield and are looking for an alternative to debt. And value stocks fit the bill since they offer high dividend yields and cash flow yields along with a margin of safety due to their earnings visibility. Hence, going forward, the performance of value stocks should improve and the underperformance of value to growth is expected to end.
In India, sectors such as PSUs (excluding banks), utilities, and infrastructure and capital goods are offering deep value.
Compared with the 10-year government bond yield of 6 per cent, many stocks in these sectors are giving attractive dividend yields of 6-10 per cent. They also offer good earnings visibility as well as free cash flow yields of 10-15 per cent.
Hence, even though they may not offer significant capital appreciation, they would be attractive for investors who want to do a reallocation from debt to equity in the current environment of low interest rates.
PSUs (excluding banks) and utilities are currently at 25-45 per cent discount to their long-term average on a P/B (price to book) and a P/E (price to earnings) basis. Some of them are currently available at a P/B of 0.75-1.5x, which makes their valuations attractive.
For companies in sectors such as coal and power, there are some concerns on the environmental, social and governance (ESG) front.
However, as long as these companies offer stable earnings and ROE (return on equity), they should do fine. In addition, they are offering good free cash flow yield and dividend yield which makes them attractive for investors.
In order to kick-start the economy, the government has reiterated its intent to invest in infrastructure as it is the biggest growth multiplier. Hence, the infrastructure and capital goods sector presents a sizeable opportunity. The sector is currently at a discount of 50-plus per cent to its long-term average on a P/B basis.
Some of the companies in this space have good order books and earnings visibility, and are available at P/E levels of 8-15x, making their valuations attractive. However, investors need to be selective and invest only in those companies that have strong balance sheets.
Lastly, some companies in the mid-cap IT space and in the media sector are also offering decent dividend yields and free cash flow yields and are available at a discount or close to their long-term average on a P/E or P/B basis.
Admittedly, the value theme has not played out in India over the past few years. However, in an environment where interest rates are expected to remain low for the foreseeable future, value stocks deserve serious consideration as they offer high earnings yield and dividend yield.
Investors who want to enter the equity asset class but are worried about volatility can start by investing in value stocks. Pension funds that have been investing in ETFs (exchange-traded funds) but not directly in stocks can also invest in a basket of value stocks.
It is an opportune time for investors to appropriately understand where the pockets of value and position are in their portfolios to capture the upside over a three- to five-year horizon. To do so, investors can allocate a portion of their portfolio to PSU funds.
The writer is Co-CIO, Aditya Birla Sun Life AMC