How to add value to your portfolio

What you’ll learn:

• How you can find value stocks.
• Why unique and smaller businesses may offer potential for profit.
• How to broaden your investment approach..

No-one can predict which way the stock market will move next with any certainty, and recent periods of volatility may have unnerved some investors.

Investors will hopefully have a spread of investments to weather various stock market conditions. However, there are ways to potentially add value to a diversified portfolio, for those who are willing to take some risk. Here, we consider some investment strategies that may increase gains over the long-term.

Yet remember that whatever your investment strategy, there is the risk that investments may fall as well as rise, and you could get back less than you initially put into the market. If you’re unsure where to invest, you may wish to seek professional financial advice.

Finding value investments

‘Value investing’ is an investment strategy that’s popular among some famous investors such as Warren Buffet. It involves searching for stocks that are undervalued by the market, so they are currently cheap, and may provide an opportunity for investors. They could be undervalued for a number of reasons, including perhaps a sudden management change, restructure, or bad press that may be an over-reaction to current events relating to a particular stock or sector, and which results in share prices taking a fall. Investors may choose to invest in these stocks in the hope that their fortunes will change over time.

Value investors will focus on companies with strong fundamentals, which are also likely to pay consistent dividends, despite their value being currently mispriced by the market. Consistent paying of a share of profits to investors in the form of dividends suggests that a company is essentially profitable.

There are tactics that investors may use to identify stocks that may be undervalued, such as working out the price-to-earnings (PE) ratio. To calculate this, you divide a stock’s share price by its annual earnings. A company PE ratio should always be considered alongside the sector’s PE to determine how a business is performing in comparison to its peers. If the PE ratio is low, it could potentially be a value investment.

Find out more about value investing

Search for unique businesses

As an investor you may already hold a range of businesses which have been around for decades as the foundation for your portfolio, either within funds or as individual shares. However, another strategy to add value is to find and add unique businesses which may have an edge over their competitors, and that you believe have potential for success.

For example, this may include smaller companies in innovative sectors such as technology and biotechnology, with potential for long-term term growth. However, you may decide you want to focus on sectors that you have some knowledge of, to ensure you pick those companies that are truly disruptive within their field. This may provide a way to diversify away from larger firms in sectors such as utility and mining, which form the basis for many portfolios.

Find out more about how to invest in healthcare innovation

Smaller companies may also be targets for mergers and acquisitions, with the chance that they’ll be picked up by larger firms that are keen to expand their businesses, offering further potential for growth.

Remaining invested over the long-term means there’ll be more time for smaller or unique business to have the chance to expand, with the hope that they will ultimately produce positive returns. Of course, there may be some volatility involved in any investment you choose, and particularly if you’re investing in a young company with an innovative business model. Investing in smaller companies involves a greater degree of risk than many of their larger counterparts, as some will fail. However, if you have done plenty of research you will hopefully be relatively certain that a company should be able to weather difficult economic conditions and avoid being tempted to sell at the wrong time.

How to invest

Examples of value funds include the M&G Recovery fund and the Schroder Recovery fund, both of which invest in a range of companies whose share prices appear low relative to their long-term profit potential.

Investors wanting to add exposure to smaller companies with the potential for growth to their portfolio may want to consider smaller company funds. Examples include the Henderson UK & Irish Smaller Companies fund, and the Investec UK Smaller Companies fund. Bear in mind, however, that investing in smaller companies is riskier than investing in larger companies. Smaller companies, for example, can be more vulnerable during economic downturns, as they are likely to have less spare cash on their balance sheets to deal with difficult times, compared to their larger counterparts.

Remember that our mentioning these funds doesn’t constitute a recommendation. If you’re unsure which investments to choose, seek professional financial advice.

Alternatively, another option is to consider investing in individual shares in companies listed on the Alternative Investment Market (AIM), London’s junior market for smaller firms. However, remember that individual shares listed on the AIM can carry a greater degree of risk for investors as their performance relies on their particular circumstances, compared to a fund which spreads risk among dozens of companies. It’s also worth noting that here is no minimum market capitalisation for companies looking to list on AIM and they don’t require a trading record, which means many of the companies which join the market have only been around for a short period of time. Smaller company shares are also more illiquid too, which means that they can be difficult to sell when you want and at the price you want.

Bear in mind too that all investments can fall as well as rise and you may get back less than you invested. If you’re unsure where to invest, consider professional advice.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.