What is value investing?
Value investing is defined as a stock-picking strategy that aims to invest in stocks that are considered as undervalued compared to their true value. It generally involves some aspects of fundamental analysis. Benjamin Graham is widely known as the “father of value investing” after he had succeeded in investing by applying the principles he founded. His most famous student, Warren Buffet, is currently the second wealthiest person in the world, also admittedly applied the concepts of value investing.
Investors who use this strategy believe that the market tend to overreact to good and bad news, resulting to stock price movements that are not relative to the company’s long-term fundamentals. Thus, value investing paves way for investors to enter the market when the price is deflated and be able to ride the rising trend when the market is due for correction.
Investing in “good” undervalued stocks
Value investing is different from simply investing in undervalued stocks. It does not mean to just buy any stock that declines and therefore seems cheaply priced. There is a huge difference between a value company and a company that has a declining price. Learning how to identify the intrinsic value of a company is a must in order to see its true potential.
Value investors look for stocks with strong fundamentals. These include earnings, dividends, book value, and cash flows. Value investors seek value stocks that are selling at a bargain price despite having a good quality.
A value investor’s mentality also lets him see stocks as a vehicle to owning a company. A value investor makes a profit by investing in a quality company, not by trading it. Because of this, value investing is only applicable for a long-term holding period. It does not aim to recognize instant gains. Value investors don’t mind the external factors affecting a company, such as market volatility and short-term price fluctuations. They firmly believe that a quality company will be able to bounce back after some downturns.
Investing on bargained prices
We may understand value investing better by thinking of it as a sale. A lot of consumers buy smartphones nowadays. A wise consumer, however, knows that there are certain times that a smartphone will be on sale. Thus, the wise consumer waits for a sale to happen before he or she buys the smartphone, unlike the others who willingly bought the smartphone at its original price. Regardless of the price paid, both consumers availed the same product, but only one was able to maximize their gains.
Margin of safety
Of course, like any other stock-picking strategy, value investing does not guarantee to make profits. Because of this, value investors always have a margin of safety. Following the steps of Benjamin Graham, value investors only buy stocks when they are two-thirds of their original price or less of their intrinsic values. Thus, letting the investors earn the best returns while minimizing investment downsides as well.
Value investing is a long-term strategy. It does not give investors instant gratification of their decisions. Undervalued stocks may crawl slowly upwards, but patience will eventually pay off. Discipline is also a must in value investing. There may be times that the market looks as if it’s going against you, but holding for a long time normally helps investors ride out the short-term price downturns. An investor needs to have discipline in sticking to their investment policy in order to reap good harvests out of it.
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