Analyzing stocks during volatile markets
May 1, 2012
Volatile markets may induce anxiety for some investors, but they can also offer exciting growth opportunities for those best equipped to understand the unique challenges and risks of volatility. Navigating this risk-reward landscape requires a disciplined investment process that fully assesses and manages both of these important aspects.
In the following commentary, Ty Nutt, leader of the Delaware Large-Cap Value team, discusses how his investment processes help to analyze and weather difficult markets.
Large-Cap Value team: A democratic process
"We work democratically rather than as individual decision makers. During volatile markets, it's been very helpful having a diverse team of committed value investors supporting one another in the process." — Ty Nutt, portfolio manager
The work style and personalities on our team have played a positive role in addressing the challenges presented by volatile markets. A defining aspect of our team is that despite the economic environment, we're methodical and deliberate about making changes in the portfolio.
Seeking to build a greater margin of stability
As part of our fundamental research, we develop bull, bear, and base scenarios for potential holdings. This helps in setting price targets, including an upside target (based on an estimate of intrinsic value over a three- to five-year period), and a downside price that's reflective of risks. We are most interested in the tradeoff between potential upside and downside, relative to a stock's current price. This analysis always entails a number of valuation methodologies (for example, discounted cash flow, analysis of valuation multiples, and break-up or sum-of-the-parts evaluation). The bull, bear, and base scenarios are developed for all new investments, regardless of when the assessment is made during the business cycle.
Through the years, the team has learned to appreciate the opportunities that become available at different points in the market cycle. For instance, in the two-tiered market of the late 1990s, value investing was considered passé and irrelevant. A large number of attractive "old economy" companies were trading at single-digit price-to-earnings ratios. In our view, this circumstance enabled us to build a greater margin of stability into the portfolio. Historically, this served our portfolios well in the downturn from 2000 to 2002.
Maintaining diversification within a concentrated portfolio
Regardless of market conditions, we stick to our strategy of owning positions in all 10 sectors of the portfolio's benchmark. Although the Russell 1000® Value Index is the performance benchmark for the portfolios we manage, we have always used the S&P 500® Index as a measure of sector weightings. We believe the index provides us a broader representation of the U.S. economy and stock market.
Consequently, our holdings show more sector diversification than might typically be expected within a fairly concentrated portfolio. We believe this structure, along with the consistency of our investment process despite extremes of market sentiment and price over time, are keys to our portfolios' long-term historical success. Never have we been tempted to change our process, despite the pressure of periodic underperformance.
We don't pretend that investing is a perfect science, but historically we have found our brand of value investing to be an effective approach over the long term.
Delaware Investments aims to blend the entrepreneurial spirit of a small firm with the shared and deep resources of a large organization — a mix that allows our team to focus entirely on investing. This comprehensive infrastructure that underpins our team provides us with a wealth of support and distribution capabilities.
Within each of our portfolios, we:
- believe stock prices are influenced by human emotion and crowd psychology.
- seek to capitalize on discrepancies between estimated intrinsic value and price, buying at times of excessive pessimism and selling at times of undue optimism.
- remain relatively concentrated as to reflect our deep convictions.
The views expressed represent the Managers' assessment of the market environment as of April 2012 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.
Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting the fund literature page or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Because the Fund expects to hold a concentrated portfolio of a limited number of securities, the Fund's risk is increased because each investment has a greater effect on the Fund's overall performance.
All third-party marks cited are the property of their respective owners.
The S&P 500 Dividend® Aristocrats Index measures the performance of large cap, blue chip companies with the S&P 500 that have followed a policy of increasing dividends every year for at least 25 consecutive years.
The Russell 1000 Value Index measures the performance of the large-cap segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.
Indices are unmanaged, and one cannot invest directly in an index.