Value Investing in 2012 Will Require More Investigative Skills

Occasionally we publish guest articles from authors not affiliated with VSG. Opinions expressed in these articles are of the author’s and does not necessarily reflect mine. It is important to read other points of view. In this article, Tom Cleveland from the team at ForexTraders gives his take on what value investing principles should be noted going into the new year.

The final quarter of the year is finally upon us, a time for celebrating the year that has been and for preparing for the one to come. Amidst the holiday cheer, investors will traditionally focus upon their respective portfolios, dump their non-performers for tax benefits and look for ways to improve their returns going forward. For the long-term investor that trusts his value investing principles, it is easy to get caught up in the market frenzy that speculators salivate over, but picking new equity holdings in this frenetic environment will require more due diligence and research skill than in years past.

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The simple reason for the difficulty rests in the fact that many share values have been beaten down during 2011. Many apparent “bargains” may only be losers in disguise that will float to the top when your favorite screens are applied. The current year was filled with uncertainty, creating a high level of volatility and downdrafts based on pure speculation alone. Yes, corporate earnings were at high levels, but simple bottom fishing will not be enough to ferret out the true “gemstones” in today’s mix of potential winners.

Most experts agree that 2012 will be a continuation of the current year’s “weather”, primarily driven by the following three fundamental trends:

  • The European “malaise” will not go away any time soon. Major structural changes to the Eurozone treaty may take years to adopt. In the meantime, Europe will struggle to grow;

  • China and its Asian partners are in “cutback” mode, if ratcheting back from 9.5% GDP growth to 7.5% is worthy of that description. Focus in the region will be developing internal infrastructure while maintaining current export levels;

  • The United States is actually exhibiting signs of a stable economic recovery, but an election year is in the offing. As the world’s number one economy, it is our responsibility, after all, to lead the global economic recovery.

In this era of globalization, however, these three trends cannot operate independently. Global commerce is intertwined with interdependencies that few truly understand. The timing and coordination of these three factors could drastically distort the quest for profits in the medium term. We must remember that nearly 50% of the profits of our S&P 500 companies are derived from overseas, so very few companies are insulated from what happens on the global stage.

Within this backdrop, here are a few value investing principles to be mindful of:

  • Safety and Soundness First: When the seas are choppy, it is better to be in a bigger boat and one that has proven its mettle in the past. Look to major Blue Chip stocks for relief, especially the ones that pay high dividend yields on a consistent basis. Over 40% of the Dow Jones participants pay dividends in excess of 3%;

  • Screen Your Screen: Value investors will typically screen for companies based on share price ratios related to earnings, cash flows, and asset values, the idea being to select entities with track records for growing revenue and profits over a 5-7 year period. The second step becomes evaluating if the market value is significantly below “intrinsic” value, assuring a safety margin for acceptable future appreciation. The companies that appear today will also require additional research since the market is so turbulent. Compare your potential selections against their industry peers to ensure that they are truly values and not junk masquerading as quality;

  • Check the Technicals: Before you buy, do review technical indicators for prudent timing. Optimizing your entry point can produce sizable opportunity gains up front.

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