Is it the right time to shift to value stocks? – Must Read

Is it the right time to shift to value stocks? – Must Read

3 MIN READ
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Growth and Value style of investing are two of the most popular approaches to invest in stocks. On one hand growth investors look for companies that offer strong growth potential whereas value investors look for stocks that are currently undervalued. It is always being argued that one is better than the other, however, the truth remains that both these approaches have yielded strong returns if invested at the right time.

Why is that?

Let’s put this into context with the economic cycle. Below is the graph which represents a typical economic cycle. From point one to two this is the expansion phase of the economy wherein the growth stocks lead the charge. Going ahead towards point two, the overall economic expansion leads to more stocks getting into the growth phase. Therefore, investors then turn their focus to value stocks where they believe the risk-reward ratio would be favourable. At point two, economic growth starts to peak out. This could either be temporary or the global economy is tumbling.

Economic Cycle

So from point 2 to 3, investors prefer to stick to companies that are not affected by the slowdown. So what happens at point 3? There are two possibilities either the economy recovers or it continues to slide and we head towards recession. If we see a recovery, then the growth stocks have already run up and are possibly trading at expensive valuations, so the investors focus more on value stocks at this point in time, again due to better risk-reward ratio. And if we head towards recession, then more companies would now face the brunt of slowdown and would no longer be growth stocks. In such a scenario, equity as asset class losses interest as investors look for safer assets like Debt or Gold. 

Let’s put this into perspective.

The Indian markets have had a decent run in 2019 primarily led by buoyant mood of global markets. This has led the Nifty and Sensex trading at lifetime highs despite expensive valuations. Further, the rally is limited only due to a few select stocks. In 2019, out of BSE500 companies only ~27% have managed to beat the index returns of 11% (till November 30th) whereas the rest of the stocks have grossly underperformed. These stocks outperformed as most of these companies delivered healthy growth despite overall economic slowdown. Therefore, in a typical scenario from point 2 to 3 wherein the economic growth is sliding, investors chose to stick to companies that have been least affected by the slowdown.

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What next?

There are two possibilities either the economic growth continues its downturn or we see a recovery. We believe the probability of the latter happening (economic recovery) is higher as the government has taken several measures in order to get growth back on track. Additionally, the recent RBI rate cuts augur well for revival in consumption in India. However, the transmission from banks has been minimal till now, but we believe that in quarter or two, the loan interest rates would be much lower.

Further, the global economic growth which had lost momentum due to increase in interest rates and US-China trade war has seen signs of recovery. It is expected to continue on the back of central bank’s (across the world) dovish commentary and signs of easing trade tensions. Therefore, at this point in time wherein growth stocks are trading at expensive valuations, the risk-reward ratio is definitely not in favour of growth stocks as economic recovery would lead to limited upside potential and downturn could lead to sharp correction in the stock. On the contrary, value stocks provide valuation comfort, so the downside is protected even if economic growth continues to slide. However, if there is recovery which we believe would be the case, then value stocks would outperform.

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