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 speak with Ryan Fitzgerald, vice president for U.S. and international equities at Beutel Goodman Investment Council. We talk today about global value equities and how they can help navigate inflationary concerns and volatility. We asked about pendulum swings between growth and value, avoiding traps, and we started by asking how he defines value investing.

Ryan Fitzgerald (RF): Value investing can be defined in many different ways, and it has certainly changed over time. The way we look at value is a high-quality business that’s trading at least 50% below our estimate of intrinsic value. And if there’s one financial metric here that we like, it is return on invested capital. If that can compound over time, that’s the ultimate get-rich-slow scheme in our opinion. After we assess the quality of the business, then we look at the valuation. A discounted cash flow analysis is almost always part of our framework. But we might look at other metrics such as price-to-earnings, enterprise value to cash flow. We’re almost always trying to look at the cash-flow generation of the business and figure out how sustainable that is, and then put a conservative multiple on it. If we can still get to 50% upside over our holding period, then the stock represents great value to us.

How value stocks perform compared to growth.

RF: I think that the growth-versus-value debate that’s been raging by market commentators and pontificators over the last year is more nuanced than what the headlines suggest. Almost always this question is oversimplified. For one, the definition of growth and value has changed over time. But also, your choice of benchmarks — starting date and ending date — and the time frame that you’re using, can radically change the conclusions. Very often the conclusions are known before the dates are chosen, depending on if somebody is a proponent of value investing or growth investing. When we talk about value versus growth, it does not consider downside protection. It’s not risk adjusted. Classic value investing typically puts a large emphasis on what’s known as margin of safety. And that is, if everything goes wrong, how much do I lose? And for a value investor this should not be very much. We’re looking for very solid downside protection. And we spend as much time thinking about the downside as we do for the upside.

The nature of value stock performance.

RF: We have to parse out the different areas of value. Value sectors such as staples and big pharma were not always considered value sectors, but they certainly were over the last couple of years. These are recession-resistant types of industries. You know, people will still keep buying their drugs, they’ll keep buying their food, so the cash flows tend to be very stable. The intrinsic value of the business does not change as the economy ebbs and flows. If we look at other areas of value — energy — it’s obviously currently working very well, and providing investors shelter from the storm. I would point out, that’s not really related to this growth-versus-value debate. That’s more related to the underlying oil price. Now the underlying oil price is going to be dictated by a complex array of factors and all of these factors interplay with one another in complex ways that are hard to figure out. But in our opinion, the valuation gap is still historically wide. Now it’s not as wide as it was. You know, if we were to have had this discussion back in January, favoured high-growth sectors such as information technology, they’ve corrected a lot. And meanwhile things such as staples and energy have done very well. So that valuation gap has certainly closed. But it is still well above historical norms.

About value traps and secular risks.

RF: Value traps are always an occupational hazard to the value investor, no matter what the environment. Value traps and secular risks, these are intertwined dynamics. What most often trips up a value investor is that they mistake a cyclical problem with something that is actually structural, luring in a value investor when there was really a secular problem that was brewing all the time.

And, finally, what’s the bottom line when it comes to investing in value over growth.

SB: Value investors are always… they should anyway get excited when markets correct, because that’s when the bargains show up. And so that’s why we’re pretty excited these days. Particularly the down-side protection that puts an emphasis on margins of safety. If you can protect on the downside and then pick up those bargains that the downside is serving up to us, it’s a wonderful time for picking stocks as a value investor.

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

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