Question

If a mutual fund lists in its mandate “we invest in value stocks” explain the major characteristics of the stocks and the companies you would expect to find in that portfolio.

Answer 1

Different mutual funds have different mandates and they use different types of portfolio management and stock selection process. When the mutual fund states that they invest in value stocks they basically invest in stocks which are undervalued and sell them when they reach potential price. Some of the characteristic of the value stocks are:

· Low price to book ratio is one of the major characteristics of the value stocks. Stock where the price is less but the book value is high. These types of stocks can be found in distressed stock or seasonal stock during their downturn.

· Low price to earning ratio is also other characteristics of the value stocks. Again, these types of stock can be found in seasonal stocks whose revenue are dependent on certain season or cycle.

· These stocks despite the low price they do have high free cash flow being produced by their operation so high free cash is also very important. Companies with high free cash flow can be where the non-cash flow expenditure is high like depreciation but the revenue generation is also very high.