This is especially imperative if you are planning to invest in a company as you should seek to understand the company’s long-term plans, financial structure and also its management team.
Hence, opting for value investing would be a smart move as value investing puts emphasis on looking into a quality company with a big potential in the market in the long run.
#1 What is Value Investing?
Now, you might be wondering what exactly is Value Investing? By definition, value investing is an investment strategy where those who opt to invest would aim for stocks that are deemed to be undervalued by the market.
To highlight, this process would need the investors to find underpriced stocks, and then proceed to buy and hold them for a period of time until the value of the company becomes significantly prominent in the market.
Hence, most of these stocks usually derive from small companies which have a great potential to have their share prices increase more significantly in the future.
So, who are the two most famous value investors?
Benjamin Graham is a name that you should be familiar with. Regarded as the “father” of value investing and also one of the best investors to have lived, Benjamin Graham is the person responsible for coining the concept of Value Investing along with David Dodd.
After the introduction of this concept, there have been a myriad of investing methods created and used by investors all around the world.
In the 1920s, the process of selecting stocks was mostly done by mere speculation.
Hence, the introduction of the new method of investigating the value of a company was groundbreaking.
This concept of value investing was introduced by Graham and Dodd as they had outlined all about Value Investing in their book entitled Security Analysis.
The second important figure in the world of value investing is Warren Buffet. As such, the concept of value investing had been learnt, practiced and also altered by many reputable investors much like Buffet himself.
To note, Warren Buffet had benefited a lot from investing which is aligned with his gained reputation as one of the most successful investors in the world.
His success is owed to his investing strategy where he opted for value investing and this had caused many people to take an interest in this concept. Consequently, there have been many best-selling books written on Warren Buffet and his investing principles.
However, it’s interesting to note that Warren Buffet had modified his very own investing strategies based on the guidance from Benjamin Graham and that there isn’t an exact strategy used by Warren Buffet.
#2 Value Investing: How It Works
So now what are the types of investors out there? Are there different types of investors? Well yes, there are!
The two types of investors are:
- Short-term investors
This type of value investor would buy and sell their stocks for a short period of time. This short time period can range anytime from a day to several years.
- Long-term investors
Long-term investors seek to buy and hold the stocks until their value increases in the market. Hence, this type of investment would take a long period of time.
Essentially, there are two sets of skills that are crucial for value investors to be equipped with in the pursuit of generating profits in the stock market.
First and foremost, interested investors should analyze and evaluate the stocks.
Through this process, the investors will be able to evaluate and determine the stock’s intrinsic or true value. Next, once the value investors have identified the value of the stock, you can apply the concept of “buy low, sell high”.
This is when you buy a stock when the price is below its intrinsic value and sell the stock after its intrinsic value is above its price in the market.
Thus, you can evidently gain a fair amount of profit by buying stocks in the stock market. Ultimately, it comes down to your ability to be able to decide which stock would be the most ideal to be bought with its intrinsic or true value.
Hence, value investing is all about the concept of “Buy Low, Sell High”. Here’s a key takeaway, make sure there’s a big difference between the buy and sell points because this will be a good indicator that you will get a high return on investment!
So why has value investing become more popular over the years?
The popularisation of value investing became more prominent as more and more distinguished investors started to adopt this strategy.
Renowned figures in the world of investing like Benjamin Graham, Warren Buffet, and Philip Fisher had gained the interest of many interest investors.
Not only that, the concept of “Buy Low, Sell High” is also a crucial key factor to succeed in investing as there is a higher chance of gaining a high investment return.
#3 Five Characteristics of Value Investing
There are several methods that value investors should adopt in the pursuit of intelligent investing. Hence, it is of paramount importance to look at the characteristics of value investing.
- Valuation Metrics
Value stocks tend to be traded at cheap prices and the first essential step to be done is to identify stocks with low P/E and P/B ratios.
What are P/E and P/B ratios you may ask? Well, P/E ratio or Price-to-Earnings Ratio is when you compare the P/E ratio with other companies. Smaller companies generally have a low P/E ratio and hence would be the best option for investment as their market price is cheap.
On the other hand, P/B ratio is the Price-to-Book Ratio. It is important for a value investor to look into a stock that is capped at less than 1 for the P/B ratio as this would indicate that the price is cheaper than the equity of book value.
- Intrinsic Value
Graham had used the technique of determining the net-net value of a company which can be done by valuing the company based on the current assets that it has.
Current Assets – Total Liabilities = Net-Net Value
It’s important to opt for a company with a net-net value that is positive as this is a good indicator that the company’s liabilities can be covered by the current assets.
- Debt-to-Equity Ratio
When choosing a company to invest in, try to look out for one with a low debt-to-equity ratio. Those with a higher debt-to-equity ratio tend to be more susceptible to higher risks as the profits for borrowed funds have to be larger than the debt’s interest.
- Price-to-Free Cash Flow
Price-to-FCF Ratio = Price / Free cash flow per share
Generally, cash is regarded as the most liquid asset of a company. The free cash flow of a company would represent the cash flow accessible for all the stakeholders. Hence, consider going for a company with a low number of price-to-FCF Ratio as this is an indicator that the company is underpriced.
- Company Fundamentals
Bear in mind that although the stocks fit the criterias mentioned earlier, they are still not a guarantee that the value stocks are good because some stocks may be cheap for other reasons.
Hence, the best thing to do is to do research on the company of your interest beforehand by looking at the company’s fundamentals such as the financial statements, its scope of industry and the potential challenges.
#4 Bonus: Dividends
Take note that a small company generally does not have a fixed dividend policy. It is crucial for you to choose a company with the ability to pay a good dividend as this acts as a way of the company’s reward for you!
What you can do when you’re planning on investing in these small companies is to check the company’s historical payouts as a reference.
#5 Is value investing right for you?
Are you prepared for a long-term period before finally seeing the results? Do you have what it takes to carefully analyze and evaluate the right undervalued stocks? If yes, then value investing is right for you!
Do note that value investing would be more suitable for risk-loving investors. If you are looking for stability, then you might want to reconsider prior to opting for this type of investment.
As nothing is certain in this world and that life is full of surprises, the same goes with the unpredictability in the stock market.
A value investor should be prepared should there be a huge loss after investing in a value stock. If you have what it takes to brace yourself and be patient in sticking to the investment process, this investment strategy is the best option for you!
In a nutshell, we believe that value investing comes with great benefits in the long run. Don’t forget to weigh in all the pros and cons if you’re planning to opt for this investment strategy.