Value Investing

 Value Investing

Terry Smith describes himself as a quality investor rather than a value investor or growth investor.

Question is.. what is value investing and growth investing?

Value stocks trade on low valuation multiples −price-earnings (P/E) ratio, price-to book ratio and price-to-sales ratio

Growth stocks trade on high valuation multiples.

 

The trouble is that the value and growth labels are potentially misleading. Lowly-rated value stocks can be expensive and highly rated growth stocks can be inexpensive.

The value and growth labels are, however, unlikely to go out of fashion. They are used by academics for research and by investors to categorize stocks.

 

What matters is the intrinsic value of a company.

This alone determines if a share is expensive or good value. Intrinsic value is the present value of the free cash flow available to investors. This makes sense.

 

Investments should be valued in line with the cash they can return to investors. High-quality companies are good at generating free cash flow. The quality style of investing focuses on what matters: the ability of a company to return cash to investors.

 

To quote Buffett again:

"Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with managers of the highest integrity and ability."

 

ROCE

ROCE is the annual profit (before interest and tax) divided by the total capital invested. It is independent of the capital structure of a business and therefore puts companies on an equal footing.

One way of thinking about ROCE is as the lump sum return. It is the return a business generates if it had been given a single lump sum of capital. ROCE is the product of the operating profit (or EBIT) margin and the capital-turnover ratio (sales/capital employed). An increase in the profit margin and/or the capital-turnover ratio will increase the ROCE.