Value Investing

Value investing is an investment approach that combines financial analysis and business principles to make good decisions. Value investing means buying shares in a company as if you were purchasing the entire business. Value investors are focused on the intrinsic value and potential future profits of assets, and pay a price that is equal to or lower than that value.

Take note of the key phrases “buying a business”, “intrinsic value”, and “pay the price that equals or lowers that value”. These are the core tenets behind value investing.

Value investing seeks out the illogical behavior of emotional investors. Emotional investing is an ever-present feature of stock market. While the number of companies that are available to investors in the stock market may change over time, the human nature and motivations of investors don’t.

Fear and greed are ever-present and often lead to poor investment decisions that are based more on emotion than on reality.

These missed prices may occasionally become extreme (the tech boom of the 1990s, or the great depression in the 1930s), but they are still common in most markets. This presents a great opportunity for long-term value investors who are unbiased. Although this idea seems straightforward, sensible, and appealing, it’s much more difficult to implement in practice.

Principles of Value Investing

Earnings at a Low Price

Stocks that have low earnings/price ratios have historically outperformed the market and offered investors less downside risk than other equity investment options.

Buying Business

Stocks are like buying a company. You want to learn as much information as you can about the company before you invest your capital. Business fundamentals are the future value of assets and profit prospects. You want to know the company’s strategy, competitive advantages, and goals.

You evaluate whether the stock price is within or outside your appraisal. These activities are the difference between value investing, and other forms of investing that require you to pick popular stocks to invest in.

Conscious Appraisal

What would you pay if you wanted to buy a business? Most likely, you would be influenced by sales prices at other hardware stores as well as opinions from neighbors. You would still focus your attention on the intrinsic value of the business – it is worth and potential profit generation — and decide if the price is justified.

This process is called an appraisal of the company by value investors. To conduct the analysis of a true number, they use publicly available data and figures. This is an appraisal of the intrinsic value of the business, not just its market price.

Moving Beyond the Fundamentals

Value investing starts with an analysis of the business’s fundamentals. These are the metrics and measures that determine business performance such as profitability, productivity, and capital structure.

But it also looks at the company’s “story” in order to determine if these fundamentals will be strong or weak. It is important to not only understand the business’s current and future value but also how it will change in the future.

Ignoring Market

Value investors tend to ignore the market and avoid advisors and commentators. They focus on the company and not the market. However, they might listen to people in the industry, customers, or others who are knowledgeable about competitors. Value investors know that the market’s impact on their stocks is not relevant if they have done their research.

Stock prices can be affected by external factors like economic crises and interest rates. It is a good idea to pay attention to the markets, especially over the long term. Daily fluctuations shouldn’t be ignored. For their investments to mature, value investors can wait from a few months to a lifetime.

Questing Consistency

Value investors want consistency in return, profitability, growth, and asset value. Consistency is a way to reduce risk and ensure safety. Value investors will invest in risky businesses, but the price paid must accurately reflect the risk. While consistency is not necessary, it is important to have predictable performance.

Book Value at a Low Price

If a stock’s value is lower than its book value, it can cause negative sentiment. Low price/book value stocks offer potential downside protection, making them attractive.

Characteristics for Value Investing

Value investing doesn’t just involve long-term investments, low price to earnings (P/E), cheap stocks, and diversification. It is not the opposite of investing for growth, contrary to what the “style boxes” attached to mutual funds would lead you to believe. This list helps to define value investing and provides a more detailed explanation of its characteristics.

Long-term Investment

While most value investments can be made for the long term, not all investments that are long-term are good investments. And not all value investments can be considered long-term. As technology and market acceptance change, the best of what’s great today could soon be a memory.

Warren Buffett avoids technology stocks and other businesses that he doesn’t understand. However, even businesses from other industries see their products changing faster than ever before. There are now dozens of Tide detergent flavors available.

Consider the long-term when buying a business. However, keep in mind that markets and businesses change. If assumptions change, be ready to sell. Never forget Eastman Kodak’s example. This point is also illustrated by today’s shift from a PC-based environment to a tablet- or cloud-based computing environment, and the revival in domestic energy production.

Low E/P Ratio

All of them have P/E ratios that are below the market averages, including banks, oil companies, food producers, and steel companies. Does that mean they are good value? It can sometimes, but not always.

A low P/E ratio is a part of investing, especially when it comes to deciding when stock prices are right. However, it is not the entire story. Although banks traded with high P/Es and large dividend payouts, this didn’t help them during the 2008-2009 Great Recession.

The Opposite to Growth

You have no doubt heard the expression “Stock ABC, a growth stock, stock XYZ, a value stock” – so value stocks shouldn’t grow. Most companies view growth as an integral part of their business’s value. The potential for growth is what makes some companies good value, even if current assets or business levels don’t justify their price. Growth is the key to creating value.

Stocks at a Cheap Price

Value investors are looking to purchase businesses at or below the appraised value to ensure a margin for safety. Value investors want to be able to take risks in the event that things don’t go as expected.

Diversification

It is a common theme to talk about diversification in investing. However, the best value investors have proven that diversification will only dilute returns. You don’t need additional insurance if you’re doing value investing right. However, diversification may not be a bad idea if you are a skilled value investor. This is the point: Diversification by itself is not valued investing.

Why Should You Invest in Value Stocks

Value investing is a strategy that seeks stocks at a discount relative to their intrinsic value. This appeals to people who love to save money. To make money investing in value stocks, you only need to convince enough investors that there is a mismatch between its current price and its actual worth.

The share price should rise to reflect the intrinsic value. Then, those who bought shares at a discount will see a return on their investment.

Many investors appreciate the safety that comes with a stock purchased at a price lower than its intrinsic value. Although there is no guarantee that the stock price will fall further, it makes any potential share-price drops less likely and less dramatic.

If you are a defensive investor who isn’t afraid of risk, a good-value stock can offer both protection from losing money and the possibility to cash in when the stock market recognizes its true value.

Value investing requires patience as it can take a while for a stock to be re-priced at a higher and more appropriate level. The returns for those who are willing to wait can be very substantial.

How Does Value Investing Work?

Value investing basically means that you buy stocks when they’re undervalued and then sell them when they reach or exceed their intrinsic value. Value investors also adhere to the following condition: Allow for a margin of safety in trading value investing stock.

Stock prices can fluctuate due to many factors, including a popular market tendency that causes a share to lose its intrinsic value.

If, for example, Company A believes that it will perform exceptionally in the future, then its share prices could rise from Rs. 100 to Rs. 120, further inducing the market to raise its demand and price dramatically from Rs. 120 to Rs. 180.

After proper analysis and inspection, however, it was found that the organizational and financial structure of the company is not strong enough to withstand high expectations. Its intrinsic value is Rs. 80. It is therefore overvalued by Rs. 100.

The top value investors avoid such market tendencies and instead look for stocks that are solid long-term fundamentals. Their intrinsic value is lower because of several factors.

Value Investing vs Growth Investing

We will be reviewing traditional value investing, and then looking at alternative strategies. It is important to remember that “value investing”, and “growth investing”, are not contradictory or inseparable approaches to selecting stocks. Value investing is about selecting undervalued stocks you believe will increase in value over time.

Value investing and growth investing strategies are more about different financial metrics. There is also a difference in risk tolerance. Growth investors tend to take on higher risks. Value investing, growth investing and any other stock evaluation method have the same goal: to find stocks that provide the investor the highest return on their investment.

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