Tug of war: Quality vs value

Investment strategies can be aligned with specific factors such as value, quality, momentum, low volatility, alpha, or a combination of these. Value and quality are often viewed as opposing strategies, as they target different characteristics of a company.

The value investing approach centres on finding companies whose stock prices are below their intrinsic or fair value, often due to temporary challenges, broader market trends, or factors that fail to capture the company's long-term potential. Common valuation metrics such as low price-to-earnings (P/E), price-to-book (P/B), price-to-sales (P/S), and high dividend yield ratios help assess the degree of undervaluation. This strategy demands patience, as it can take time for the market to fully recognise and reflect the true value of these companies.

On the other hand, businesses associated with the 'quality' theme typically demonstrate strong fundamentals such as high return on equity (ROE), return on capital employed (ROCE), manageable financial leverage (debt/equity ratio), healthy free cash flow (FCF), the ability to generate superior returns on incremental capital, and good corporate governance.

These companies also often possess sustainable competitive advantages, leading to long-term stability, more predictable returns, less volatility, strong management, and sustainable growth. Quality companies usually have solid balance sheets with lower debt, ample liquidity, and resilient business models that allow them to withstand market disruptions.

Style rotation

The value style underperformed from 2018 to 2020 before making a comeback in 2021. Similarly, the quality style had mixed performance in recent years. Historically, it has been observed that quality stocks perform relatively well during uncertain times. For example, the Nifty 200 Quality 30 Index performed relatively well during 2011, 2013, 2015, 2018, 2019, and 2020. Notably, all of these years were marked by heightened uncertainty.

Since the beginning of 2021, value theme stocks have performed relatively well. However, what's interesting is that while the value theme did well in the first four months of 2024, the quality theme took over starting in May 2024. The last five months have once again been characterised by heightened uncertainty—initially related to the general election, followed by concerns around the Union Budget, the yen carry trade issues, the economic slowdown in the US, geopolitical tensions, and more recently, worries about FIIs (foreign institutional investor) reallocating money from countries like India to China.

It is important to note, as depicted in the table 'How quality and value styles have alternated as winners', that while the annual performances of the Nifty 200 Quality 30 TRI and Nifty 200 Value 30 TRI differ significantly, since inception, they have generated very healthy returns of 19.4 per cent and 17.5 per cent CAGR, respectively.

To sum up

Investors need to remind themselves that "winners rotate." Today's best-performing market segment may or may not perform well in the future, and vice versa. The broader equity market is an amalgamation of various factors. Therefore, when creating an equity portfolio, it is essential for investors to either choose a factor-diversified portfolio or diversify their equity investments across various schemes with different styles and factor tilts to ultimately create a factor-diversified portfolio. This approach should help improve the investing experience over time. For investors looking to make tactical calls on themes, as we say in football, "position yourself in the space where the ball will be, rather than chasing where it just was."

Manuj Jain, a CFA charterholder, is a Director and Head of Product and Strategies at WhiteOak Capital Asset Management Company. He has been with the company for over two years and has over 16 years of experience in asset management. Part of the WhiteOak Capital Group, WhiteOak Capital Asset Management Company is the sponsoring entity of WhiteOak Capital Mutual Fund.

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