Some investment strategies require a lot of complex mathematics, but, luckily, value investing does not demand a lot of heavy-duty thinking. You don’t need a comprehensive background in the realm of finance to accomplish your investment goals, nor do you have to subscribe to an expensive service that analyzes charts and graphs. For those who display common sense and have the money to invest, you can get involved and use the extra money to generate more money. When it comes to investing in the stock market, one of the things to remember is never to invest money you can’t afford to lose.
Value Investing Explained
Value investing looks at stocks and considers buying the securities that have been priced at under market value through some type of analysis of the market. The discount from this market price is what experts refer to as “margin of safety.” It has proven to be a successful investment strategy for some of the biggest investors like Warren Buffett, Carlos Slim, Michael Price and Carl Icahn. The entire concept basically means finding stocks at a sensible price. Value investors are people who actively search for stock that they believe has been undervalued in the market. The investors who use this strategy understand how the market will overreact to both bad news and good news. This results in movements of the stock price, and it might not remain true to the long-term pricing. When value investors understand this and do their research, they have the opportunity to profit off deflated prices.
How Does Value Investing Work
To fully understand how value investing works, we need to understand what are its main concepts and how they correlate to each other. And we can whittle down this form of investment to five main concepts.
1. Every Company Has Intrinsic Value
The first of these concepts is that every company will have intrinsic value. The key idea behind this is that if you know the true value of something, you can save bundles of cash if you only buy them when on sale. The core idea behind when you buy a stock is similar to when you buy a new TV at the listed price. You’re still getting the same TV and picture quality and it will not depreciate with time as new technology opens up, or that is the assumption. The same idea applies to stocks.
2. Maintain a Margin of Safety
The second concept is that you always have a margin of safety. Buying stocks at a bargain price means that you have much higher chances of earning a profit once you decide to sell it off. In addition, it makes you less likely to lose money.
3. Efficient Market Hypothesis is Wrong
The third concept is that the Efficient Market Hypothesis is wrong. If you talk to most value investors, they don’t believe in the concept of stock prices at face value—in truth, they’re either overvalued or undervalued.
4. Go Against the Grain
The fourth concept is that a successful investor separates himself from the herd and cuts through the foliage to forge his own path. If you become a value investor, you may look like a contrarian at times. That is because you deny the value of the Efficient Market Hypothesis. And when everyone else buys in, you’re selling your stocks off.
5. Patience, Patience, Patience!
The fifth principle is that true investing, that pays off over the long term, requires real patience and diligence. You can’t buy a stock for $62 on Thursday night and expect to sell it for $100 profit by Monday morning. In fact, Warren Buffett has developed somewhat of a reputation for hanging onto his stocks for up to a decade before he sells it off.
Charlie Munger, a partner of Warren Buffett at Berkshire Hathaway, says that shrewd investment involves this form of investing, getting more than you pay for. You have to value the company you’re investing in if you want to see real value in the stock. Munger also says to move only when you have the advantage to do so. A lot of people make the mistake of swinging at too many pitches. But some of the best investors know how to prowl the savannah like a hungry lion in wait.
Advantages of Value Investing
Education and background doesn’t bar you from becoming a successful investor
Because you wait out the short-term fluctuations, you profit over the long term
Profits continue to grow over time
Your earnings generate more earnings
You can increase even the smallest amount when given time
Less risk than short-term investment strategies because the market’s daily fluctuations don’t trap you
Disadvantages of Value Investing
You have to do your homework if you will pick successful stocks
Gut instincts mean you lose money
Evaluating whether a business will be worthwhile takes both time and effort
Most days you won’t even notice a big change in your stock holdings
Estimating intrinsic value can be difficult
You have to examine all the information to succeed
Sometimes you will encounter unpredictable factors
Value Investing Exemplified
Carl Icahn exemplifies this form of investment almost perfectly. He argues about how Apple stock has been undervalued by as much as 50 percent, and it should trade for around $203 per share. Icahn writes about how this undervaluation will soon disappear, and the prices will shoot up. Based on the value formula Benjamin Graham proposed, Icahn came to the conclusion that Apple had been valued a bit low. For example, Apple’s earnings estimate in 2014 sat at $6.33 per share. That’s a growth rate of around 10 percent in 2014 and 15 percent in 2015. Plugging this information in, Graham justified the P/E of 8.5+25-33.5. He then took the earnings of $6.33 and multiplied them, which gave him a real market value of $212.05 per share.
That information looks pretty good. But the price earnings growth ratio divides it by the P/E to examine the long-term growth. You could certainly profit a little off Apple, but what Icahn realized was how the potential for profit was not as good as expected. For example, Apple’s 1.9 percent yield produced a ratio at 1.10. That suggests that while the Apple stocks weren’t expensive, they still weren’t the best deal. However, this is how you make use out of this form of investment formula. You can use it to check the intrinsic value of almost any company to determine how the stock prices measure up. And whether they have been undervalued or overvalued.
Unfortunately, there’s no universal way of determining the intrinsic worth of a company. But, if you follow the formula Benjamin Graham and Warren Buffett use, you increase your chances of turning a profit in this volatile market. The advantage of value investing is how it reduces the risk. Because when you buy lower, you have less to lose. What has been your experience with this form of investment? We invite you to leave a comment below talking about your successes and failures with it.