The top researcher at a firm managing $89 billion told us the 3 ways he analyzes whether a cheap stock is set for a surge, or if it's a trap
- Michael Mullaney, the director of global markets research for Boston Partners, broke down his approach to value investing by saying he prizes fundamentals, valuation, and business momentum.
- Inexpensive value stocks have delivered strong returns in the last few months after a full decade of market-trailing returns.
- Mullaney's firm has tens of billions of dollars invested in a variety of value-focused funds.
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There's reason to think that after a decade trailing major benchmarks, value stocks might be on the comeback trail.
The group of inexpensive stocks has lagged its growth counterpart throughout the bull market, leaving some experts to say the approach may never work again. Others have predicted rallies that quickly fizzled out.
Michael Mullaney is the director of global markets research for Boston Partners, a firm with $89 billion in client assets and several major value funds. He's not predicting that value is finally pulling ahead of growth, but he does say that the value approach will always have its uses, especially for people who want to find investments they'll keep for years.
"Value is an investment philosophy. It's not a trading philosophy," he told Business Insider in an exclusive interview, contrasting that approach with the more active trading investors tend to take with growth stocks.
While value investing by definition focuses on stocks that look inexpensive, Mullaney says price alone isn't enough to identify a promising target. He explains that his firm is guided by three criteria when it's picking potential value investments, and puts money into companies only when all three look good.
Fundamentals
While earnings are the main fuel for stocks and the market, Mullaney says they're not his primary focus when he's looking under the hood at how well a company is performing. He prizes cash flow as a way of determining how much an underappreciated company could deliver.
"It's really cash flow-based metrics that we emphasize, and not even so much P/E metrics," he said. "It's really cash flow [and] price to cash flow based metrics which are paramount."
Valuation
It's a given that defining a company's valuation is important in value investing, but again, Mullaney emphasizes the criteria he's using are based more on the company's cash flows than on its earnings. That may not be as useful when it comes to predicting the company's future performance.
He argues that some traditional value metrics don't work as well as they once did, forcing him to look elsewhere. One that's become nearly "obsolete," in his view," is the price-to-book value, a way of evaluating a company's worth by dividing its share price by the value of all its assets.
That's because companies, and especially the most successful ones, now derive so much of their value from intangible, hard to measure assets like intellectual property instead of physical assets like manufacturing plants.
"It's just so hard to delineate what you're really talking about when you're talking about what the book value is of a company," he said. "So-called asset light companies have done extremely, extremely well for the last 10 years."
Business momentum
Momentum might be the single most important characteristic to Mullaney, but he's talking about the momentum of a business, not just momentum in a company's stock price. That's his way of evaluating whether profit, sales trends, and returns on invested capital and equity are getting better or worse.
"Is there, one, a catalyst that's changing within a company to potentially make potentially, its prospects better, or two, have you seen discernible improvement in their underlying fundamentals?" he asks.
He explains that if a company's business trends are poor, he stays away from it even if its valuation and fundamentals look fantastic because that's the thing he most wants to avoid: A value trap whose price is likely to sink even though it already looks cheap.
"They're basically just living off the past," he said of those companies. "They've got decreasing sales, they've got decreasing profits, generically they're coming from a higher level to a lower level, and there is no catalyst on the horizon that says that's going to turn around."