This Museum says there are no ‘value’ stocks. Why it matters.

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When a drug company

Pfizer

and his companion

BioNTech

announcing in November 2020 that they had developed an effective vaccine against Covid-19, something deep happened in markets.

In the nine months leading up to that first wave of positive vaccine news, investors poured money into names as an online retailer

Amazon,

electric car manufacturer

Tesla,

and an e-commerce platform

Shopify.

These “growth” stocks were up and running in 2020.

But as vaccines appeared on the horizon, a seismic shift occurred: Investors moved out of these investments in favor of “value” stocks hit by the Covid-19 pandemic, such as airlines.

This rotation was based on this essential concept: There are some stocks that are clearly valued based on standard measurements.

And it’s completely flawed, according to a study from ValuAnalysis, a London-based asset manager and equity investment store, which is particularly valuable.

The dichotomy between value stock and growth stock

The similar difference between growth stock and value stock is that the former is overvalued based on underlying metrics while the latter is undervalued.

Growth stocks get their name from the expected growth that is priced in the shares. Stock value seems to trade at a discount compared to their fundamentals.

“Everyone knows that this doesn’t make any sense because growth is no different from value,” said Pascal Costantini, who led the research. Barron’s.

Must read:Are big tech stocks in bubbles? Not according to this museum

Analysts use meters as the price-to-earnings ratio, or multi-price, to value a stock. ValuAnalysis uses price as a lot of normal free cash flow as its benchmark. The imaginary division line between stock value and growth is at 35x, which is the middle of the market.

Costantini argued that this 35x multiplication is not a difference between two stock types, but just a point of growth gradient.

“It’s just semantics, it doesn’t matter – just that,” he said. “Because everyone is leading a package analysis on this divide. ”

The team at ValuAnalysis described the asset management industry as forcing managers to put stocks in one box or another, anchoring their records around this 35x settlement point.

Value? More like low growth

So why are some stocks priced so much lower than 35x free cash multipliers? Costantini said it is because the market is pricing the stock considering the true cost of capital as a criterion for growth.

ValuAnalysis identified the true long-term return of equity as between 5% and 6%, and there is an inconsistent relationship between the multiple price and cost of capital in a static model. So, all else being equal, that means low growth companies will not come together at multiple earnings between 17x and 20x, which is the opposite of 5% and 6x. %.

Based on this, investors should look at the multilateral earnings as a fundamental indicator of growth. A change in the risk price on the investment can move the needle on the valuation, but a real increase of the multi-performance is achieved by increasing free cash flow.

The value vs. growth segment shows that a company trading at a multiple earnings of 17x is valued. In fact, ValuAnalysis said it appears to be a company that will not grow.

Value tracks and how you can avoid them

Relying on value vs. growth classification allows investors to fall into what is called ValuAnalysis as a value trap.

In this scenario, an investor would mark a stock trade significantly below the heterogeneous mid-market price and falsely assume that he has legs for a much higher run.

The most common value trap is the “jam tomorrow” promise when a legacy company promises new business with ambitious growth targets.

This is attractive to investors, but unless the company actually increases the free cash flow, such as by getting rid of low-yield businesses to favor high-yield businesses , there is no reason to think that the company will grow.

So how do you choose a low value stock?

Stocks that are not properly valued will trade between 25x and 35x free cash flow, Costantini said, going above the cost of capital but not the middle of the market.

To grow, a company’s accumulation of assets or revenue growth must be the cause of an increase in gross domestic product, and appropriately show signs of acceleration. There must also be an increase in operational reductions through revenue or margins. A reduction in the risk price helps.

Determining the value of a company is not the multi-tasking, but it is a good place to start.