Value investing involves discovering the intrinsic value of assets, and also developing the patience to wait until they can get them at prices that are lower than their intrinsic value. In this article, we will look in detail at value investing, discuss some key takeaways, how to value invest, and also consider other alternatives to value investing.
What is Value Investing?
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value. It is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental analysis. In the words of the most successful practitioner of value investing; Warren Buffet, “It is better to be approximately right than precisely wrong”. One guiding principle for value investors is investing in a company whose price is at or below its intrinsic value.
- Value investing involves picking stocks that appear to be trading for less than intrinsic or book value.
- Certain metrics are used to value a company’s stock and they include price-to-book, price-to-earnings and free cash flow.
- Value investors don’t buy trendy stocks because they are typically overpriced.
Strategies of Value Investing
Like any type of investing, value investing has its principles and strategies. However, some general principles have been outlined by some of the most successful value investors. These value investing principles include:
- Buy Businesses, Not Stocks
Businesses and stocks are two different parts of investment. This is one principle all value investors agree on. Buying businesses and not stocks means ignoring the trends in stock prices and other market trends. Here are seven ways you can invest in a business:
- Ownership investment
- Debt investment
- Investment partners
- Public vs. private investment
- Venture capital
- Angel investors
- Franchise opportunities
- Love the Business You Buy Into
This is the first step of value investing. You shouldn’t pick a stock based on cursory research, instead, you have to love the business you are buying into. This includes taking time to learn everything about the company, getting passionate about the company even to their business. If you like the business you are buying, paying attention to all their activities, ongoing trials and successes becomes something you do with joy.
- Invest in Companies You Understand
There is no better way to say this, other than understanding the dynamics of a company before you invest. If you don’t understand the basics of a company, then you shouldn’t invest or think of buying shares. You can buy the business you like, but you don’t understand and this is why you have to think of this factor too.
- Ignore the Market 99% of the Time
There will be market noise, but you have to learn to ignore the 99% of the time. The market only matters when you enter or exit a position. If you buy a stock as a value investor, you will want to hold onto them for as long as the fundamentals are still strong. By ignoring the trend and holding an investment with unrealized gains for a long time, the longer you avoid capital gains and transaction costs and also benefit from compounding.
- Don’t Stress Over Diversification
Diversification is a technique that reduces risk by allocating investments across various financial instruments, industries and other categories. It aims to maximize returns by investing in different areas that would react differently to the same event. Diversification is one of the areas where value investing runs contrary to commonly accepted investing principles. Generally, investors are supposed to avoid concentrating on only a few stocks, but in the case of value investors, they generally feel they can keep proper track of a few stocks at a time.
Value investing as a type of sensitive investing requires a lot of discipline on the part of the investors, but in return, it offers a large potential payoff for the time spent.