Beware 'value traps' in bargain bins: fund managers

Singapore

IT does take courage to buy value stocks, Andrew Lyddon, an equity fund manager at Schroders, said at the November Schroders International Media Conference 2018 in London. While a market correction can translate into higher odds of oversold stocks and overpriced risks, it also requires a certain boldness to buy and hold onto an undervalued stock, especially if prices do not recover soon.

It is "not for everyone's stomach", Mr Lyddon said. "Value investing at its heart is a behavioural strategy. It benefits from the behaviours in stock markets - the fear, grief, envy and worry when your portfolio is going down for days on end; the exuberance when you see it rising higher day after day. Value investors try to step out of that, strip out those emotions, and exploit them for their own benefit."

That is not to say that anything in the bargain bin is worth buying. Some basic parameters need to be in place, too. For Mr Lyddon, these include a strong balance sheet, profits that are turning into cashflow, and the ability of a company to cover one's cost of capital over an average investment cycle. The no-nos for him that would keep him from buying a stock, no matter how cheap it is, include shady corporate governance and the tendency of a company to sit on cash rather than distribute dividends.

Sat Duhra, portfolio manager of Janus Henderson's dividend income strategy, said that regionally, there are a number of unattractive sectors such as some industrials and telecommunication service providers, which may appear cheap, but face key structural headwinds that multiple-based valuations (such as price-earnings ratios) cannot capture.

"More detailed and sophisticated modelling . . . can price in these scenarios and would reveal that actually there is no value in these names."

He added: "Companies increasing free cash flow, improving balance sheets and with positive dividend surprises are much less likely to be 'value traps' and this has been true of the energy and materials sectors since mid-2016. These kinds of value names are attractively valued and performed much stronger than growth sectors such as technology in 2018."

Asked why Singapore was only his portfolio's fifth largest investment market after China, Australia, South Korea and Taiwan, and why there were no Singapore stocks among his top 10 holdings, he replied that he is only positive on Singapore banks, thanks to rising dividends and a clearer non-performing loan outlook, but other high-yielding sectors such as real estate investment trusts remain "quite expensive".

He added that comparing markets on the basis of standard deviation and price-earnings metrics can be "misleading" and "flawed". This is because companies may have encountered weakening margins, a changing competitive outlook, structural threats, and higher financial leverage over the years, which would not necessarily be captured by simply taking the price-earnings measure today. Earnings can also be manipulated by changing accounting policies.

At the same time, he also feels that markets such as Thailand, South Korea, China and Taiwan currently present stronger ideas for dividend growth, while being supported by more resilient macro fundamentals.

READ MORE: Telco, bank, consumer stocks among bargains in discount bin: analysts