Value Investing Delivers Safety And Growth Amid Market Uncertainty

We Indians love a good bargain. Known for our haggling skills, we take pride in not overpaying - whether it’s for a product or a service. After all, why pay more than what something is truly worth?

Now, what if we applied this same logic to the stock markets? Just like any other purchase, we should only pay as much for a business as its fundamentals justify - or ideally, even less. But certainly, never more.

That’s exactly what value investing is all about - identifying quality businesses trading below their inherent value, and investing in them with a long-term perspective. The upside here is that when the underestimated, mispriced businesses achieve their potential, markets reprice them higher resulting in capital appreciation for the investor. In contrast, if we buy businesses with elevated valuations not supported by fundamentals, the potential for upside is limited as prices are already stretched, and the scope for sharper drawdowns increases.

The strong post-pandemic bounce back of the Indian economy resulted in a multi-year bull run for Indian stock markets. Underperformance of Chinese equities since 2020 further contributed to India’s attractiveness. Valuations started to run ahead of fundamentals. This rally was disturbed in the final months of 2024. An unexpected economic slowdown hurt corporate earnings which was followed by a slew of earnings downgrades. At the same time, announcement of government stimulus in China improved prospects of cheaply-valued Chinese stocks. Both these developments led to an outflow of global money from India. The resulting correction has moderated domestic stock valuations to align with global markets, but they still remain expensive compared to other emerging markets and long-term averages.

In such an environment of valuation excesses, opting for value-oriented mutual funds can be a smart strategy. Value-oriented mutual funds are equity mutual funds that follow the principles of value investing. The fund manager identifies and invests your money into stocks that are undervalued or offer a margin of safety i.e. they are available at a discounted market price compared to estimated intrinsic value. Intrinsic value is an estimate of the business’s worth based on its future cash flows, earnings potential, growth prospects, management quality etc. These stocks typically have strong underlying fundamentals and long-term potential but are temporarily out of favor due to a short-term company-specific issue, external factors or general market sentiment. Fund managers buy these stocks with the expectation that markets will eventually price them in accordance to their intrinsic value, which will help generate better returns. Value-oriented funds can thus help you avoid overvalued stocks and sectors in the current environment, which are sooner or later going to be susceptible to an unwinding in prices to reflect the fundamentals.

Value-oriented funds tend to underperform during momentum driven rallies when growth funds outperform. But these funds have the potential for above-average returns over the long term as excesses get eliminated and markets reward fundamentals. Risk is generally lower in these funds on account of the margin of safety which acts like a cushion in case of a fall in intrinsic value. These funds are ideal for investors with long investment horizons and a preference for optimizing risk-adjusted returns over more volatile, high risk-high return bets.

Value-oriented funds can be a good complement to growth-oriented funds in an investment portfolio for a more balanced risk-return profile.

Disclaimer: The Views are Personal and not a part of the Outlook Money Editorial Feature