Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life.

For today’s Soundbites, we’re asking if now’s the right time for value investing. Vim Thasan, vice-president of Canadian equities with Beutel Goodman Investment Counsel, offers his take on value opportunities. We started by asking why it may be time to look beyond growth stocks.

Vim Thasan (VT): In our view, valuation always matters. Over the last several years, low rates and high-growth expectations — particularly in some sectors like technology — resulted in high multiples and business valuations. In fact, speculative values were applied to some businesses that were growing quickly but with negative free cash flow. Concerns about a recession and the normalization of pandemic trends are impacting business growth. And at the same time, higher interest rates raise the cost of debt and equity. Both of these factors lowered multiples, and the most pronounced impact has been in more speculative growth areas. Our process focuses on quality franchises with sustainable free cash flow generation that’s trading at a discount to our estimate of intrinsic value. These businesses do not require hyper growth expectations or free money to feed our assessment of intrinsic value. And we buy these franchises with a one-third discount to our estimate of intrinsic value to provide a margin of safety which buffers the downside.

What he likes about value stocks.

VT: We look for quality franchises with strong competitive moats, and sustainable free cash flow generation. We do our homework and wait patiently for these opportunities to present themselves. We aim to benefit from a concept called time arbitrage because we look out three to five years, while the market may look out three to five days or weeks. This lets us form a view of the company that may be different from what’s reflected in stock prices or market expectations. This long-term focus is ultimately rewarded because the market is a voting machine in the short term, but it is a weighing machine over the long term.

Timeliness and ROI.

VT: The timeliness of returns isn’t in our control, and it can damage the effective ROI in the case for all investments. However, in our view, avoiding capital loss by owning a portfolio of companies at a discount to the intrinsic value is critical to effectively compounding capital over the long term. Markets are ultimately driven by fear and greed and short-termism. As value investors, our job is to take advantage of these emotional cycles and invest in companies at attractive valuations that can provide that path to long-term value creation. We can’t predict if an individual company thesis will play out in three months or three years, so we aim to build a diversified portfolio of seeds that we’ve planted, which often work at different times. And sometimes there are some weeds in the portfolio that need to be rooted out. This disciplined value investment process has historically delivered attractive risk-adjusted return for unit holders over the long term.

Sectors and regions he likes.

VT: We’re finding that a fear of a consumer recession is creating opportunities in select parts of the consumer discretionary and financial sectors, where there is a concern of peak earnings, and a concern of a rapid decline in that pace of earnings. Now, this spans across industries like retailers, auto parts companies, and banks. For us the first-level thinking is the earnings risk and the near-term concerns of earnings risk. But the second-level thinking is, what’s priced into these expectations and stock prices? So, we may consider — and we do consider — near-term earnings but we try to look through to what normalized earnings potentials is for each of these companies. Another source of opportunities may come from company-specific situations where there is a mis-execution or misallocation of capital that creates discounted valuations. And we’re seeing such examples in the pipeline space and the technology space.

The relative value of conventional wisdom.

VT: The market tends to create simple stories to explain very complex situations of what’s happening to a company or stock. Conventional wisdom is generally an easy story that fits. It’s important to break apart the companies, and then build them back up. This lets you understand the nuances of what will drive future value, not just a simple story.

And finally, why is now the time to start looking for returns in value stocks?

VT: We’re not trying to forecast an economic direction or form views of a soft or hard landing. We’re looking for company dislocations in specific areas that present themselves through the cycle of fear and greed. And we believe they can be found.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Vim Thasan of Beutel Goodman Investment Counsel.

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