Throughout our many decades as investors in the sharemarket, we have lived through various periods where people begin to seriously question whether using a value philosophy can still yield good long-term results.
This question generally rears its head when sharemarkets are driven by momentum or themes, and becomes more intense when stockmarkets are racing away or hitting record highs. During these periods, valuations can seem almost irrelevant and are often not allowed to get in the way of a good story.
In a perfect world, every company’s share price should track the sum of its long-term discounted cash flows. Of course, in practice, we know that companies’ shares can be extremely volatile as investors are influenced by each company announcement as well as the daily news headlines and a barrage of constant information from various sources.
The impact of quant and index funds
Ever-increasing computing power has led to the popularity and proliferation of quant and algorithmic-driven funds which can now process and act on data in a matter of seconds. The vast majority of these quant funds use very short-term momentum indicators as their primary buy/sell signals, which has had an increasingly major impact on share price movements in recent years.
When a stock is in an “upgrade” cycle and near-term consensus earnings estimates are revised up, even by relatively small amounts, most quant funds will invest in and continue to buy a stock, often with very little reference to the underlying valuation of the company.
Similarly, when a company disappoints on the earnings front, even by a small amount relative to consensus, many of these funds will continue to sell the stock down to what can become significantly undervalued levels.
The popularity and huge inflows of money into index funds have also added to the distortion of many share prices, in our view. As quant funds push stock prices to extreme high or low valuations, this clearly has a major impact on the market capitalisation of those companies. This, in turn, affects the index weight of stocks, which then leads index funds to buy or sell a stock because its index weight has changed.
Our view is that the large flows of recent years into both quant funds and index funds have led to huge volatility in many share prices, with any incremental positive or negative news often leading to distortions in the share prices of many companies.
Where does this leave value managers?
The current environment is a challenging one for value managers. Value managers use a range of analytical tools to judge whether a stock price is cheap or not compared to the underlying intrinsic value of the company. These tools include price/NTA, sum of the parts (SOTP), discounted cash flow (DCF) and PE ratios.
It is increasingly relevant to note, however, that the volatility of many share prices can actually create very good opportunities for disciplined value managers. This is because quant funds can push stock prices way above or below their true long-term value based on short-term factors, with index funds then following by buying or selling the stock based on its weighting in the index. This often exacerbates the disconnect between the stock price and the company’s underlying value.
How we assess value
At Fundamental, as bottom-up, long-term value managers, we use a range of factors to assess and calculate what we believe to be the underlying value of a company. We then await opportunities as stocks are regularly overbought and oversold, given the mechanics of what is happening in the current stockmarket and the impact of quant and index funds on individual stock prices.
We spend many hours constructing financial models for all the companies in our universe, with AI tools such as Claude by Anthropic making it a lot quicker to download and analyse the past annual reports and results of each company.
Apart from this fundamental analysis, we also spend many hours talking to company management to assess the competence of management and to understand their medium to long-term plans, including how management plans to grow long-term shareholder value. This can range from organic growth to expansion by acquisition.
We also spend many hours talking to competitors, suppliers, ex-employees and customers to collate independent information as to whether what the company is telling investors is in fact being played out in reality.
Having done the research and built an understanding of how the company’s management plans to increase shareholder wealth over the medium to long term, it is then a matter of working out a valuation for each company and comparing this to the stock price. We then look to buy stocks where we believe the share price undervalues what the company is truly worth.
By doing thorough research on every stock we select for our portfolio, we are able to understand the drivers behind each company we hold and why we believe the company can perform well in our portfolio.
Why value has its place
While the trend towards investing in index funds, quant funds and ETFs has gained huge momentum in the last few years, we remain firmly of the belief that funds with a strong value bias, such as ours, deserve a place in a diversified portfolio.
There are several reasons for this. Momentum, quant and index-driven markets can push share prices well above or below underlying value, particularly when investors react to short-term earnings upgrades, downgrades or changes in index weight. For disciplined value managers, those distortions can create opportunity.
By doing detailed bottom-up research, assessing management and comparing the market price with long-term intrinsic value, we aim to identify companies where the share price undervalues what the company is truly worth.
A further point to note is that value portfolios can have lower volatility than the broader index over time, thanks mainly to lower downside capture in negative periods, as the stocks held are generally supported by justifiable valuations rather than short-term momentum alone.
In a nutshell, while value portfolios may not always perform as strongly as booming, momentum-driven markets, we firmly believe that over the long term, our value approach can deliver solid returns for investors.
Anton Tagliaferro and Simon Conn are Senior Investment Managers of Fundamental Investment Management, an Australian funds management company focused on active value investing in Australian smaller companies, founded by Anton Tagliaferro in 2026.
This content is provided by Fundamental Investment Management Pty Ltd (ABN 34 685 636 239, AFSL 569 477) (Manager) in relation to the Fundamental Smaller Companies Fund (Fund). The information in this article is general information only and does not constitute financial advice or a forecast, nor does it constitute tax or legal advice. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, consider its appropriateness and the relevant Information Memorandum.