The concept of value has evolved significantly over the years, reflecting the dynamic nature of markets and investor sentiment. Back in 2020, the term ‘value’ was met with disdain in the investment world. Fast forward a few years, and value investing has not only returned to prominence but has also become a defining theme in the markets. This journey underscores a key truth: for any investment strategy to succeed, it must adapt to changing market conditions while staying true to its foundational principles.

At UTI, we define value through the lens of Intrinsic Value, which serves as the cornerstone of our investment philosophy. Understanding and adhering to this principle allows us to navigate the inevitable ebbs and flows of market sentiment while identifying sustainable opportunities.

Intrinsic Value: The Bedrock of Value Investing

Intrinsic Value represents the discounted value of all cash flows a business can generate over its remaining lifespan. While market prices often deviate from this intrinsic worth due to economic fluctuations or investor psychology, value investing seeks to capitalize on these divergences.

For a portfolio manager with a value mandate, the challenge lies in discerning whether market valuations reflect intrinsic worth or are driven by transitory narratives. In addressing this, we continually evaluate:

The historical valuation cycles of sectors.

The weight of prevailing market narratives on stock prices.

The balance between operating cash flows (OCF) and free cash flows (FCF) in light of capital expenditure needs.

Sector-specific demand-supply dynamics and their impact on valuation cycles.

This disciplined approach enables us to identify opportunities that align with intrinsic value while managing risks effectively.

Sectoral Insights: Lessons from Market Cycles

1. Information Technology (IT)

In 2020, IT companies saw a stark divergence in valuations based on cash usage policies. Companies favoring acquisitions over dividends faced steep discounts, reflecting their low return on invested capital (ROIC). By 2022, policy corrections, including improved cash utilization, drove these companies to trade at premiums. Today, IT valuations hover near fair value, supported by better OCF-to-FCF conversions and strong ROIC metrics. While historical valuations indicate a premium, the sector remains appealing due to its growth potential and defensive characteristics.

2. Energy and Resources

The profit cycle for Indian corporates turned favorable in FY21, marked by a rising profit-after-tax (PAT) to GDP ratio. Resource companies, once undervalued due to terminal value concerns, gained traction amid profitability surges. By 2023, however, several energy stocks reached valuations significantly above intrinsic worth, signaling caution. Weak FCF profiles in many resource companies suggest cyclical peaks, highlighting the importance of disciplined valuation analysis.

3. Banking

A robust recovery followed years of balance sheet cleanup in the banking sector. Improved regulatory frameworks and enhanced return on assets (ROA) underline the sector's resilience. Despite concerns over quarterly margin fluctuations and systemic loan-to-deposit ratio (LDR) pressures, intrinsic value considerations reveal compelling opportunities, supported by mid-teen loan growth, strong asset quality, and sufficient capital adequacy.

4. Real Estate

The real estate sector has mirrored its 2006-2008 trajectory, transitioning from discounted net asset value (NAV) valuations to significant premiums. Post-pandemic demand growth led to a surge in activity; however, declining affordability, increased property launches, and steep price hikes signal caution. Metrics have shifted from NAV to EV/EBITDA, indicating a mature valuation cycle.

5. Utilities

Utilities initially gained favor in 2020 due to stable returns and high dividend payouts, often trading below book value. However, challenges in renewable energy storage and peak power shortages have since driven valuations to unsustainable levels, often exceeding 4-6x book value with mid-teen ROEs. These dynamics, combined with execution risks in renewable projects, require prudent evaluation.

Integrating ESG and Behavioral Insights into Value Investing

The definition of value investing is incomplete without considering Environmental, Social, and Governance (ESG) factors. Companies with strong ESG practices often exhibit higher resilience, translating into sustainable intrinsic value. Simultaneously, understanding behavioral biases, such as overreactions to short-term events, underscores the importance of maintaining discipline and focusing on long-term fundamentals.

Adapting to the Current Market Environment

Elevated market valuations, fueled by sharp profitability increases, compel a deeper analysis of past cycles. While order books appear healthy, fiscal tightening suggests potential growth slowdowns. A pivot from government-led capex to private investments and consumption is underway. Slowing earnings growth necessitates a defensive portfolio approach.

Our emphasis remains on intrinsic value, prioritizing companies with robust cash flow profiles capable of self-funded growth. This disciplined approach helps navigate the risks of narrative-driven sectors, ensuring that investments are backed by sustainable cash flows and reasonable valuations.

Conclusion

Value investing’s relevance endures because of its adaptability and steadfast focus on intrinsic worth. By navigating the cyclicality of markets and maintaining a disciplined approach, investors can identify genuine opportunities while avoiding the pitfalls of fleeting market trends. As the investment landscape evolves, so too must our strategies—anchored always in the timeless principles of value and intrinsic worth.