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Understanding Value Investing

| March 22, 2018
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“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffet 

Appropriate balance sheet analysis is a crucial step in formulating the investable individual equity landscape for the strategies included in the Hefty Wealth Partners multiple strategy platform.  Risk management and sound selection are non-negotiable steps when we invest in individual equities and such a process is one that favors value style investing.  Valuation metrics tied to profitability, earnings multiples, cash flow, dividend payments, dividend growth, ability to sustain debt while also investing in research and development efforts, ability to expand capital expenditures relative to the cost of borrowing, and even the breakdown tied to the company’s projected growth rate, are just a few of the components scrutinized in the selection process.  History has favored such a value bias, especially when comparing it to companies classified in the growth bucket (Figure 1).  When comparing the aforementioned criteria across growth oriented companies, we find that they are less concerned about producing strong metrics in lieu of sales, or profit, growth.  This isn’t to say that it’s a bad business strategy but we would argue it’s one of higher risk.  The potential for higher reward is viable but so is the potential for a precipitous loss.  It’s important to note that we’re not suggesting value investing does not capture downside – it most certainly does – but the idea is geared toward stronger relative management to the downside, which may then allow for tactical shifts into asset classes that have experienced oversold conditions (this notion also ties in with the quote from Warren Buffet listed above.  In times of stress, we tend to find value biased equities performing relatively better than growth).  The value versus growth comparison has been one of historic proportions in 2017.  The Russell 3000 Growth index was outpacing its value counterpart by over 20% over the past 14 months, despite the nearly 11% total return of the Russell 3000 Value index (Figure 2).  The massive discrepancy has been tied to highly concentrated gains amidst a handful of technology stocks.  To be specific, the performance of just five companies led to such a wide spread.  These are companies that could never meet the fundamental criteria required for inclusion in our multiple strategy platform and, due to that, are equities that we cannot consciously hold.  Over the long-term, we believe our value approach to individual equity selection is superior to simply chasing returns of growth biased companies or by simply investing blindly across indices with no real conviction behind the fundamental factors of each company. 

Source:  Bloomberg.  The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  All information is historical and there is no guarantee of future results.  All indices are unmanaged and may not be invested into directly.  No strategy assures success or protects against loss. Stock investing involves risk including loss of principal.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  The Russell 3000 value/growth indices are market capitalization weighted equity indices maintained by the Russell Investment Group that seek to be a benchmark of the entire U.S. stock market. More specifically, the indices encompass the 3,000 largest U.S.-traded stocks, in which the underlying companies are all incorporated in the U.S.  The Russell Growth Index is an unmanaged index comprised of those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values.  The Russell 3000Value Index measures the performance of those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values.  Investment advice offered through CX Institutional, a Registered Investment Advisor. 

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