What is Value Investing ?
Value investors look for companies with lower-than-average sales and earnings growth rates. Their holdings frequently have lower price-to-earnings and price-to-book ratios. Although dividend rates on equities are frequently higher, the fund can profit from turnaround scenarios. The turnaround scenario provides an opportunity to benefit by purchasing equities at a discount.
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Value investing as a strategy focuses on investing in selected securities, and not just any security, but equities of fantastic companies and firms that are valued far below their Intrinsic Value.
Value investing is not a new concept; it entails an entire gamut of combination of calculations, permutations and combination regarding a company’s future performance in comparison to its current share price. At its foundation, value investing is about discovering stocks that are undervalued by the market, even in a robust bull market
Idea behind Value Investing
The underlying idea behind everyday value investing is pretty straightforward: knowing the true value of something, thereby allowing to save money when bought at a discount. Keeping the company’s valuation constant, the stock price can alter. Stocks can experience periods of higher and lower demand, thereby resulting in price fluctuations that have no bearing on what can be got for money. A value investing mindset can be seen as the willingness of a buyer to buy a particular commodity or good at a discounted price when the buyer is already aware of the value or utility of the commodity or good.
Investors are alert about the price fluctuations of the stocks and look for similar stocks. Value Investing is doing vigilante work to find price discount sales on secret stocks and then buying them at a discount vis-a-vis market values. In return, investors are rewarded handsomely for buying and holding these value stocks in the long term. The forms of value investing are derived from the investment philosophy which was first taught by Benjamin Graham and David Dodd at Colombia Business School in 1928.
Big Daddy of Value Investing
Over time, value investing has matured. Its roots can be tracked to the Great Depression and its aftermath, when the strategy’s sole concentration was on acquiring enterprises whose assets were worth more than the shares sold for. It was partly due to the fact that many firms were going out of business at that time, and possibilities to acquire stocks for less than value of assets had direct consequences when a company liquidated.
Benjamin Graham is largely considered to be the founder of value investing. Graham’s Security Analysis 1934, and The Intelligent Investor 1949, presented the foundations of value investing, including that of the idea of Intrinsic Value and the need of having a Margin of Safety Net.
How To Invest Like the Best Investors in the World
Metrics used in Value Investing
Various metrics are used in an attempt to determine a stock’s valuation or intrinsic value. This intrinsic value is arrived at by financial analysis with fundamental analysis. A few are as follows:
- Price to book (P/B)
It is the value of a company’s assets is calculated and compared to the stock price. If the price is less than the asset value, the stock is undervalued, assuming the company is not in financial distress. - Price to earning (P/E)
It is the company’s earnings track record to see if the stock price is not reflecting all of the earnings or is undervalued. - Free Cash Flow (FCF)
It is the cash earned by a company’s revenue or activities after deducting the costs of expenditures. The revenue left post-expenses, including operating expenses and substantial acquisitions (aka capital expenditures), is called as free cash flow. Free cash flow is a direct indicator of the future that the business can pay off debt, pay dividends, and issue share buyback. Free Cash Flow is basically cash at disposal (money left over) of the company after incurring the permanent cost and other related cost.
What are Value Stocks ?
Simply put, a value stock is a stock which is priced lower than its intrinsic value. (period)
A value stock is a company’s stock that is valued at roughly 48-49% of its true value. Value investors base their decisions not on any newspaper article or tip received or upon the actions of some other investor, but on a company’s intrinsic value, or upon it’s actually worth, not just its sticker price. It is of paramount importance for any value investor to know that the sticker price is not always the true value of a company.
On the other hand, a stock price if cheap does not necessarily make it a value stock. The companies themselves must have convincing history and exhibit significant development potential over time. This is why a thorough grasp of the firms in which you invest is essential to value investing.
Common Questions About Value Investing
- Can it make you rich?
To summarise, it is acceptable to conclude that the technique has the potential to generate a lot of money for you. Many of the world’s most successful investors today can be categorised as value investors in some way.
- How good is the Returns on Value Stocks?
Value investing yields returns anytime the market recognised that a firm is cheap and raises its stock price, which is a basic value investing principle: markets eventually adjust undervalued stock prices to their respective intrinsic values. So, when value stocks are priced at 50% of their intrinsic value, investors can expect a 50% return on their investments when the market eventually corrects.
- Value Investing Vs Other Investment Strategies
Day Trading, Index Investing, and Growth Investing are some of the most popular investment strategies today. Every other investing strategy has its own merit and demerit. Choose one that suits your style.
Strategies in Value Investing
To be honest, there are many strategies. However, some of the typical yet effective strategies for value investing are as follows
- Don’t Fall Prey To Fear
- Focus on Long-Term
- Proper Research on the stock
- Right Time To Buy is the key
- No to relay solely on Technical Analysis
- Fundamental Analysis of the company stock can go a long way i.r.o Value Investing
- Use of Investment Calculator
Safety Net
Value Investors require some margin for error in evaluation of a stock, thereby frequently defining and redefining their own “Margin of Safety Net” depending upon the risk tolerance. One of the cornerstones to effective value investing is the Margin of Safety Net, which asserts that buying stocks at low prices offers a higher chance of profiting later when sold. The Margin of Safety Net reduces the likelihood of losing money if the stock does not perform as planned.
What is not Value Investing
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Speculation
Speculation is the act of acquiring an asset without regard for its intrinsic value with the hope that its price will increase so you’ll be able to sell it for more than is paid. Speculation is the total opposite of value investing. -
Technical Analysis
A method of evaluating equities that involves reviewing market activity data such as prior prices and volume. Technical analysts do not strive to assess a stock’s intrinsic value, rather use charts and other mathematical & statistical tools & techniques to identify patterns that may suggest future activity.
How to identify a Value Stock
It doesn’t take a genius to find Value stocks, some of the tricks are as follows
- Focus on well-established businesses with long histories of success
- Watch out for consistent profitability of the company
- Stable revenue streams without huge amounts of growth but typically also without big sales contractions
- Last but not the least, dividend payments made by the company can also be considered, but its not a mandatory principle
What is a Value Trap ?
Value trap is a stock that appears to be cheap but is actually not
How to avoid a value trap
Some of the insights to avoid Value Trap are
- Earnings in cyclical industries related to manufacturing and construction/ architecture do grow during economic booms, only to vanish when industry conditions drop.
- Whenever investors expect a firm to bust, its value appears comparatively cheap in relation to previous earnings
- Stocks that focus on intellectual property/ copyright laws are susceptible to become value traps. Also in case of Tech. Companies that are first mover in any segment but eventually lack the ability to defend themselves in case of competition.
To circumvent value traps, when evaluating a stock, the potential of a firm is more significant than its past. Focusing on a company’s potential for future sales and profits growth will increase chances of finding real value stocks
Value Investing Vs Growth Investing
Growth investing focuses on a company’s chances of seeing its sales and net income climb rapidly with time, with a focus on the market’s fastest-growing firms.
Growth investors are less concerned about intrinsic value than value investors are, instead rely on exceptional corporate growth to justify the higher values investors must pay to purchase shares.
Suggestive Books/ Good Reads for value Investing
- The Intelligent Investor by Ben Graham
- The Essays of Warren Buffet by Lawrence Cunningham
- Security Analysis by Ben Graham and David Dodd
- Margin of Safety by Seth A. Klarman
In conclusion
Putting in perspective, Value Investment is a long-term investment game.
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
-WARREN BUFFET-