Is value investing – a valuation method pioneered in the 1930s by Benjamin Graham – still relevant today? For Graham and his followers like Berkshire Hathaway’s Warren Buffett, value means a low price relative to recent profits or the accounting (“book”) value of assets.

Its detractors argue that a share’s underlying profit and its book value don’t fully capture how modern corporations create value. The best companies have shifted from tangible to intangible capital—from an economy where factories, buildings and machinery were key to one where software, ideas, brands and general know-how matter more. Stockpickers make it their vocation to pick gaps between a stock’s price and its true worth. Three of Sri Lanka’s most significant portfolio managers, Asanka Herath, Head of Equities at Lynear Wealth Management, Vindhya Jayasekera, Chief Investment Officer at NDB Wealth Management, and Kanishke Mannakkara, Chairman of CAL Investments, joined the discussion about the relevance of value investing in Sri Lanka and their strategies to build portfolios now. Edited excerpts follow:

Asanka, there are two approaches we are discussing here: a stock’s price versus its underlying earnings, the underlying book value, and the idea that an investor might buy and hold these securities as long as the underlying company maintains a strong market position. How do you think investors should approach this in Sri Lanka’s current context?

Asanka: Investing is an art. It’s not an exact science. To me, investing isn’t limited to what Benjamin Graham said in the 1930’s. It’s more what Joel Greenblatt or Howard Marks have been saying about value investing. Which is when you invest in a company at a substantial discount to its value. A company’s value isn’t simply on its tangible asset value or the net asset value. You have to take into account its growth potential. Ultimately, in most businesses, a large portion of the value is generated from future cash flow.

To answer your other question, does it work in Sri Lanka? To buy something at a lower price than its value works in every context. But there are certain challenges, countries like Sri Lanka and frontier markets, pose to a value investor.

Typically, the value of a firm grows over a period of time. Even in developed markets. But in frontier markets like Sri Lanka, given the macroeconomic volatility, the industry volatility, and the business risks; volatility is much sharper. In certain instances, that overshooting of the share price can actually capture five years of growth and value. At that point, you have to exit.

Let me throw in some numbers that might surprise you. Did you know that Cargills Ceylon’s bottom line has grown 10-fold between 2008/09 and 2022/23? It has actually increased four times between 2011/12 to now. But if you look at it, there are large periods over the last 15 years where the Cargills share price hasn’t reflected the company’s profit performance. Why is that? Just after the war ended, the share price materially shot up capturing multi-year future growth. Sri Lankan investors need to consider that our market cycles or valuation cycles are shorter. Value investing works, but you need to exit the position the moment your price trends above the value substantially.

Vindhya, welcome to the conversation. We often benchmark the market’s performance. Fixed income yields are often a good benchmark to use for equity. Have Sri Lankan stocks, in general, delivered in the past?

Vindhya: We’ve used a lot of data points in a study we have done. If you look at the last 10 years’ market performances based on roughly 6,000 data points, the annual return is around 14%. The average treasury bill rate in the same period was around 11%. So, the 3% premium the market has returned over fixed income isn’t really adequate. Over the last decade, the market returned over 20% for only about a fifth of the time. For countries like Sri Lanka, as Asanka mentioned, where the market cycles are pronounced, investors must take action in between them.

Kanishke, has investing in the index in Sri Lanka been a good equity strategy in the past?

Kanishke: Equity returns since the war’s end have been a touch below inflation. The past and the future are not the same. I do agree with both Vindhya and Asanka. Maybe 10 years is too long a horizon for Sri Lanka; we need to consider far shorter market cycles. Within those short cycles, I do believe there’s a lot of upside to be gained.

I believe the best strategy to make money through investment in Sri Lanka is a multi-asset class strategy, where based on the outlook for the economy, you are nimble enough to move between asset classes. Within that too, I think a good holding period is maybe 18 months. From my observation of the Colombo Stock Market, I think that’s a longer period than many people will hold their shares for.

It’s important to remember that trading too frequently is expensive here and can be destructive. Every time you buy or sell shares, you spend a little over 1% of that value, so a round trip costs you 2% plus. So you need to bear that in mind before you decide to churn your portfolio.

In my opinion, a 12 to 24-month strategy has worked. Value investing is a funny concept because the concept of value that you’re talking about is historic and I always believe in looking to the future. I think if you can identify value in the future there’s a lot of upside to unlock. But going just based on past performance, I don’t think it’s the right course of action.

This round table discusses two things. The concept of value investing and also related to that is a strategy of buy and hold. We are exploring if these strategies can work as an equity investment strategy in Sri Lanka. Asanka, what’s your take on this?

Asanka: I want to be very clear. I don’t believe in buy and hold; where you’re holding beyond its value. I think all three of us will agree on that. Because value investing is not buy-and-hold. Once the price trends above the value, you have to exit.

January 2011 was when the market corrected after the post-war run. By that time some companies with the best business models, employing some of the sharpest minds and with the best brands, were trading at 15 to 20 times their trailing earnings. At that point, the share prices had captured earnings available for another couple of years. Also, at that point, Sri Lanka was facing currency depreciation and the prospect of interest rate hikes was real. The valuations were high. Then, if based on the logic of favouring the company’s strategy and its future growth, hold on to the investment, that also means your opportunity cost will be higher.

That strategy would not have made sense unless you are a strategic investor who has decided to take a 10-year view on Sri Lanka and you’re going to hold those equities for 10 years or 20 years. I just wanted to make that clear.

There are lots of investors who hold significant positions in corporations for a very long time, far longer than 10 years even. It looks like it’s working. How do you make the distinction?

Asanka: There are strategic investors, and then there are long-term investors. I should have made a distinction in my earlier comment. Strategic investors are the ones who take control and drive the strategy of the business. Given what expertise they can bring or synergies they extract with their other businesses, they believe they can create an additional value the rest of us can’t see.

Also, you can attract long-term investors who for whatever reason have decided to take an exposure to 20 frontier markets and hold it for 10 years or 20 years. One of those frontier markets, in the next decade, can turn out to be the next Vietnam. Once you make that allocation call at a high level, you are committed to it. So there can be long-term investors like that. But other than for those two very specific reasons, I don’t think a buy-and-hold strategy works.

Kanishke: I agree with Asanka. Essentially, we’re all talking about not following the herd. When market frenzy picks up, and valuations go beyond the point of sustainability, it makes sense to sell. That’s what gives us all a job, it’s important to buy at the right price and it’s also important to sell at the right price. And you can’t just be blind to that.

Are there any idiosyncrasies about Sri Lanka that make this strategy that you’re discussing more valid in Sri Lanka or less valid?

Kanishke: I think yes. So the more perfect a market the less opportunity there is for people like us to make a difference. But we are in a deeply imperfect market. The market reaction times are slow and market information filters through slowly. So, for all those reasons, somebody who can take an educated guess about the future is at a distinct advantage.

Why do you suggest the market reactions are slow and information takes a long time to filter down here?

Kanishke: Because of low liquidity, low level of sophistication amongst investors, unavailability of capital, the size of our capital market, all of these things.

Asanka: I think your question was, are there market idiosyncrasies about Sri Lanka, that makes a buy-and-hold strategy that much more riskier?

I agree with what Kanishka said. I want to add another perspective. Sri Lanka is such a small economy. Whatever the claim maybe our innovation is very small. Our global integration is poor compared to say the US, or even Singapore or Vietnam. Western companies are global, if their home market slows down they can expand overseas, and their brands are global.

Those companies listed in those markets have more structural opportunities to grow. Sri Lanka doesn’t have that. A short sharp market movement in a country like Sri Lanka can easily overrun the value of the businesses. In a country like the US, those structural growth opportunities ensure that value can grow at a faster pace in those businesses than in a country like Sri Lanka.

Vindhya: The breadth and the depth of the market is rather limited. We have 290 listed companies and the average market turnover has only just started to pick up. In the last 5 to 10 years, we haven’t really seen high turnovers as well. So this is a market where substantial investments in a stock in itself can drive up a stock price, and at that point, you should think if the stock price has come to a level that is fair and if you should exit.

So to your point, Asanka, Sri Lankan companies are also far less sophisticated than obviously ones from the US or Singapore.

Asanka: I hope the management of these companies won’t stop taking my calls now.

Because you’re suggesting the multiple they bring to the table for their intangibles is lower than the US or the big European companies. So in that sense, your job is easier? Because there is less intangible potential to consider?

Asanka: So let me answer the two questions. We can’t generalize by saying that all aspects of intangible value in our businesses are lower if you compare them with other frontier markets. In certain sectors, our management capabilities are almost comparable to developed markets. That’s what keeps driving some of our businesses in the current context. Especially in the banking sector.

But here’s the other catch. If you take that high-level view, that our businesses will invariably struggle to growstructurally, you can miss out on those one or two companies which will actually grow very structurally. You want to be mindful of that. Sometimes, that multi-bagger that has generated alpha over the last five to 10 years can be that company, simply because of the intangible that has grown over the last 10 years.

Kanishke: I’m going back to value and I haven’t seen an opportunity to value invest across an index. But certainly, we’ve seen several examples where there was deep discounting because of perceptions. Hayleys, 18 or 24 months ago, was a prime example of this. In late 2020, the market capitalization for Hayleys was Rs16 billion. We saw a similar case with Aitken Spence, and in both instances, we took aggressive positions in those companies. Maybe Dialog is an example of that today. There are periods when you see deep discounting of certain companies, and there is an opportunity there.

But I don’t know whether that’s a value investment strategy, or simply spotting market mispricing. I think asset mispricing happens a lot in our market and there’s a lot of opportunity to make money from that and that’s what we focus on.

Vindhya: It is part of the value investment strategy to consider asset mispricing. I think that is where we as fund managers add value by zeroing in on mispriced or undervalued assets.

Is it generally true that the Sri Lankan market is not so good at dealing with companies that can have a higher share of value from intangibles?

Asanka: It’s not just intangibles; the market is imperfect, the market is inefficient. A factor is that our market is under-researched. So compared to more developed markets, our market is poor at assessing value. Therefore, you can end up under-assessing or over-assessing the growth potential of a company.

The danger is that the market will never realize its mispricing, is it?

Asanka: That’s the interesting part. Our philosophy is valued with a catalyst. You want to buy into a company that is cheap, but you need to estimate when the catalyst could be. The catalyst could be the next quarter’s earnings, dividends, M&A, etc.

Value with catalyst. That makes a lot of sense. Kanishka, you mentioned the unsophistication of the Sri Lankan market. We see this all the time, the market reacts to the reported quarterly earnings significantly, almost as if nobody anticipated these earnings. Is this a peculiarity now because there is so little participation or has this been borne out in the past?

Kanishke: It was even worse in the past, in my opinion. So I remember a time, maybe around 2006 when people didn’t look at price-earnings ratios and they acted purely on rumours. Then there was this great move towards looking at PEs. And now we are looking at, maybe one quarter ahead. Sometimes you witness a market run based on future earnings too. Expo was a classic example of that happening. So I would argue our market is slowly growing in sophistication, but there’s a long way to go. That’s where professional investors can hopefully outperform the market over the long run because there is so much headroom.

So there is so much opportunity to find value here and the only thing to look for is a catalyst that can then unlock that value for you, because otherwise, the market may never realize that value. How would you approach this?

Vindhya: Like what Asanka suggested, you have to look out for the next event. When you think a company is undervalued, ask why think so. Is it based on earnings performance alone or would there be some event that you think might unlock value? You need to consider if the market will realize the event you forecasted when it comes to pass.

Like Kanishke was saying, the market is more sophisticated now, it’s reacting to information faster. It’s a different market to what we had in 2009-10; the post-war era. There’s a long way to go. But certainly, things are improving.

When you talk about catalytic events, Asanka, do you focus on ones affecting the company in question, or are you talking about catalytic events as far as the economy or the market in general is concerned?

Asanka: When it comes to value investing and catalytic events, it’s primarily company-related. But it can also be industry-related. I’ll give a classic example. Seven to eight years ago Hayleys Fabric went through a very rough patch making deep losses trying to develop this fairly unique product portfolio. They were hoping, that when it succeeds, it will bring them volume growth and high margins. It’s difficult to quantify the value of what they were trying to do. You can build a position and when they start reporting a few quarters of profit that’s an ideal company-related catalytic event.

But if you look at more recent events, consider the banking sector. I think most of us in this room understand that banks are undervalued. The moment there was greater clarity on the domestic debt restructuring proposal, the entire industry rallied. So it can be, mostly, company-related, but it sometimes can be industry-related.

So look at the context here, a lot of managers in Sri Lanka have had a lot to deal with over the last decade or more. There was the war and …

Asanka: 40 years of crises to deal with.

Yes, 40 years. That’s possibly right?

Asanka: War, JVP, the issues over the last three to four years.

Do you think that there is intangible value in the know-how within Sri Lankan companies about navigating crises? Haven’t they done an exceptionally good job navigating crises? Is that capability or value likely to be unlocked?

Kanishke: I wouldn’t over-emphasize that as a point of strategic difference. The Russian economy is a classic example of this. Extremely resilient, but it’s resilient because it’s not performing at its maximum potential. An F1 car will break down all the time because you’re pushing it to its limits. A Toyota Corolla that you drive at 40 kilometres per hour will never break down because you’re not.

Just because we are resilient doesn’t mean we are performing. I love some of the companies in Sri Lanka and I believe very strongly in them but that’s not my reason to invest.

Asanka: I think compared to the frontier markets, all of which face frequent crises, our management is exceptional. But if you put the same management in a more developed market where there are structural growth opportunities, I feel that most of the time they will come across as more conservative. They are used to firefighting, but not structurally growing their businesses.

Kanishke: Where I think we stand out amongst other frontiers is in terms of the authenticity of the numbers. I believe that most of the time what is reported are genuine numbers. That also says something.

Are we as a market at an inflection point, because the intangible value underlying companies, like brands, IP, management quality, etc will matter more in the future than it has in the last 10-20 years?

Vindhya: If you look at the Sri Lankan market in terms of brands, who are you trying to capture? Our population is just 21 million, our population size itself might not be enough to create value based on intangible assets like brands. But if a company is looking at growing outside Sri Lanka and you’re catering to a much larger market, there might be something to additionally look at in that sense.

Are the ground rules changing here, Kanishke?

Kanishke: I’m not yet convinced. I don’t see that as a catalyst that I consider imminent. Even the companies that are expanding overseas, with the exception of Expo, are not giving them a higher multiple. Take JAT for example, It’s trading at a very poor multiple, even though they have genuine potential to go outside. I don’t think we’re necessarily valuing it in that way. I’m also not convinced that this will be the inflection point.

I do think valuations are at an inflection point in terms of growth because there’s so much to be unlocked. But in my opinion, this is not it.

Asanka: I think I tend to agree with Kanishke. I think it’s too early to call it an inflection point or not.

In terms of intangibles?

Asanka: In terms of intangibles. But the key thing is, you can’t value a business just by looking at tangibles, you have to consider the intangibles too. Taking into consideration both tangibles and intangible values of most of the listed equities in the market, the market is materially undervalued. I think that’s something I can say with certainty. It’s too early to call whether the market will give a greater weightage to intangible values going forward.

Kanishke, you said that 12 to 18 months is a good holding period. How does that compare with the past? Is it different? Are your holding periods likely to shrink as a result of the market sophistication?

Kanishke: No, the investment period doesn’t shrink with market sophistication. I would argue that although things will move faster, my investment horizon will lengthen with stability. So, if we see some of the reforms being discussed coming to fruition, independence of the central bank, and many others, then hopefully we will have greater stability and with that, we might increase our investment horizon from 18 months to 36 months.

Vindhya: Sri Lankan policy is volatile. We have seen interest rates of 4% in 2020 that went up to 30% two years later. Even in 2019, we experienced similar volatility. This is the reason why we have such intensity in value being realized way before that earnings potential. So, that’s why sometimes our investment horizons are short. Although we take a long-term view of the company and we invest, sometimes we can sell the share in 12 to 18 months because a lot of what we have forecast is reflected in the share price sooner.

But as Kanishke put it, as the economy becomes more stable with economic reforms, then the volatility will reduce leading to longer stock holding periods.

Asanka: The reforms happening now, if sustainably implemented, will address some of the long-standing structural issues Sri Lanka has faced.

If the twin deficits are addressed, our interest rates can remain reasonably low for a protracted period and our currency will be stable. This means that equities will be attractive to both local and foreign investors.

Higher FDI flows will come to Sri Lanka and if we push through trade agreements, the market opportunities for Sri Lankan listed companies will grow. So the structural opportunities will be greater. I think that’s what we are all saying. Right now, from what we see, the investment horizon is about 12 to 18 months. The investment period can lengthen based on whether these reforms are irreversibly implemented. We are all hopeful that it will happen.

Great conversation. I will ask each of you to put any final thoughts on the table. Can I start with you, Kanishke?

Kanishke: As investment managers, we are trying to unlock value. The key question is unlocking it effectively to actually make money for our clients, which is what we’re trying to do. In my opinion, that’s about looking at the future and not the past.

Sri Lanka is evolving and I think if you take the very long term, we have evolved in a positive direction despite very obvious blips. I remain optimistic about the future of our country. The crisis has taught us that we need to reform and I think those reforms have started from institutional independence to trade liberalization.

Removing protectionism for Sri Lankan firms will force them to compete and eventually make our businesses stronger and globally more competitive. So we sincerely hope stuff like that will happen. Greater stability will emerge and then our investment horizons will be longer and valuations will be higher.

In the very short term, we are thinking purely from an investment perspective over the next 12 to 18 months. We think there is an upside even without all of that stuff. All of that will be the icing on the cake.

Vindhya: I started the conversation by saying that, when you look at the last 10 years you haven’t seen our share market give stellar returns; 14% is what it has returned. But that shouldn’t mean that we are going to invest in the entire share market. The entire share market won’t give us returns because of limitations of breadth, depth, liquidity and such factors. But if you pick and choose the right stocks, which is what we talk about in value investing, I think there is a lot of potential.

With the right economic reforms, there is a lot more potential to hold stocks for longer tenures and to realize higher returns, in line with emerging markets and even developed markets.

Asanka: At the risk of repeating, irrespective of all the long-term reforms, equities can generate substantial returns over the next 12 to 18 months. The second thing is on a personal note, I’m actually hopeful that some of these reforms will get implemented. As an example, petroleum sector liberalization is probably a 40 to 50-year-old discussion and it has been implemented. Because a crisis pushes people to do things.

Today, if you really look at it, more than any point in our recent history, there is political capital in support of reducing government expenditure, rationalizing government institutions and privatization.

So I remain hopeful that there is a great opportunity for sustainable reforms, and I think that may happen and that might mean that our equity market run can last much longer.