What is Value Investing?
Value Investing Overview
Value investing is an investment strategy that involves selecting stocks that are trading for less than their intrinsic or book value. Value investors actively seek out stocks that the stock market is undervaluing. They believe the market sometimes overreacts, resulting in stock price movements that do not accurately reflect a company's long-term fundamentals. This overreaction offers an opportunity to buy stocks at discounted prices.
WarrenBuffett is probably the best-known value investor, but there are many others, including Benjamin Graham (Buffett's professor and mentor), Charlie Munger, David Dodd, Christopher Browne, Seth Klarman, and Mohnish Pabrai.
“Value investing developed from a concept by Columbia Business School professors Benjamin Graham and David Dodd in 1934 and was popularized in Graham’s 1949 book, The Intelligent Investor.”
The basic concept behind everyday value investing is pretty straightforward: If you know the true value of something, you can save a lot of money when you buy it on sale. Stocks work in a similar manner, meaning the company’s stock price can change even when the company’s valuation remains the same. Stocks go through periods of higher and lower pricing due to occasional irrational market fluctuations—but that doesn't change what you get for your money.
It makes no sense to pay full price for a company’s stock if you can buy it on sale. Value investing is the process of doing detective work to find these sales on stocks and buying them at a discount compared to how the market values them. In return for buying and holding these value stocks for the long term, investors can be rewarded with rising share prices, profits, and returns.
Details on Value Investing
Investors use various metrics to attempt to find the valuation or intrinsic value of a stock. Intrinsic value is a combination of using financial analysis such as studying a company's financial performance, revenue, earnings, cash flow, and profit as well as fundamental factors, including the company's brand, business model, target market, and competitive advantage.
There are many other metrics used in intrinsic analysis, including analyzing debt, equity, sales, and revenue growth. After reviewing these metrics, the value investor can decide to purchase shares if the the stock's current price versus the company's intrinsic worth is attractive enough.
Based on their particular risk tolerance, value investors require room for error in their estimation of a company’s value, which they refer to as a "margin of safety”. The margin of safety principle, one of the keys to successful value investing, is based on the premise that buying stocks at bargain prices gives you a better chance at earning a profit later when you sell them. The margin of safety also makes you less likely to lose money if the stock doesn’t perform as you had expected.
Example of Value Investing
Let’s say you have done your due dilligence, researching the fundamnentals of Apple (AAPL). You have determined that Apple’s intrinsic value is $100/share and and it is currently selling for $50/share. You’ll make a profit of $50 (a 100% return) simply by buying and waiting for the stock’s price to rise/reset to the $100 true intrinsic market value.
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