What is Value Investing?
Value investing, as the name suggests, is based on “quality”. The value investors and traders tend to choose stocks that are trading in the market at a lower value than their congenital value. Value investors continuously lookout for the stocks that are underestimated by the market. In terms of value investing, the investors are of the opinion that the market tends to exaggerate both the good and bad news. And this exaggeration has no or menial effect on the long term functioning of the companies. Thus exaggeration lets the traders buy the profitable stock at a discounted price.
How does Value Investing work?
The core concept to keep in mind while pursuing value investing is that if you know the true value or quality associated with a stock, then you can save up a lot of capital by buying it on discount.
Yes, the concept works just like when we shop for clothes or other items on sale. You know that a bag or a dress has high value due to its brand recognition and quality. But since it is now available at low prices on sale, then why not reap the benefits!
This works in the same way. The price of the stock can swing upwards or downwards when the valuation of the associated company still remains constant. The sharp investors are just like shrewd shoppers. They both believe why to pay higher prices for stocks or other products when you can buy them at the sale.
Obviously, the stocks won’t go on sale at particular events, and their discounts do not get advertised either. Therefore, a value investor needs to dig up and keep an eye on the market every now and then. With this, one must spy on the market and dig up the gems from the innate deep market. When investors buy and hold on to such value stocks for the long term, they can get stunning returns.
Three golden rules to remember
Take your time to do thorough research about the companies that you want to invest in. you must understand and learn the following things about a company:
- The fundamental and principles of the business
- The long term goals associated with the company
- Team and their history of work (CEO, CFO, top management)
- The financial structure of the company
Value investing is centred mostly around companies who pay out dividends on a constant and consistent basis. The reason is that the come of age companies which have high profits often give back to their investors. Value investors may not care about how the media is portraying a particular company but tend to understand the long and short term earnings, inner workings of the company.
Secure and stable returns
This is hard to swallow, right? Everyone in the investing world wants quick and high returns. But do not buy the stocks that are hyped.
If you are hearing about those hot stocks after they have been in the limelight for some time, then the chance has already gone.
Rather, put time and energy into finding stocks that can complement secure and stable returns. It is unrealistic for investors to look for stocks that will boost up in the market exponentially and provide high returns.
That kind of miracle is most of the time, impossible. Even if you find such miracle bearing stocks, the truth is they are not going to last at that level for long.
Therefore many clever and intelligent investors want stability rather than abrupt market-beasting stocks.
Diversify like a pro
Do not make the bouquet of just white flowers. Would it not look bland? Same goes with value investing. You would want various kinds of stocks in your portfolio instead of making a bland of the same stocks. Creating a varied and diversified portfolio is essential in value investing for protecting the investors from potential risks.
How to Analyse the Intrinsic Value of the Stocks
There are many factors that have to be looked upon to find the intrinsic or congenital value of the stocks. Such factors include the financial history of a company, cash flows, returns and revenues, capital gain of the company, and more.
A value investor might also do some detective work to find out the stocks of particular companies and undervalued in the market. They must also look out if these companies have the capacity to pull up from such undervaluation.
Some qualitative indicators also play a major role in determining the inherent value of such stocks precisely. Such qualitative factors can be if a company is involved in any financial scam or difficulty, the credit rating of the company, or the estimation of loss and profits during the previous recessions.
Metrics for finding the inherent value of stocks
- Price-to-earnings ratio (P/E): This ratio depicts the relationship between the share prices of a company and the earnings per share. This ratio is useful for value investors because it depicts how much the investor must invest in a particular company to earn a dollar of its earnings.
When the earning per share is low, the P/E ratio rises and vice-versa. A high ratio implies that the organisation or business is probably undervalued.
- Price-to-book value ratio (P/B): This ratio depicts the per unit book value and per unit share price of a company. When the share prices are less than the book value, it means that the stocks are undervalued and vice-versa.
- Earnings before interests and taxes: The earning before interests and taxes of a company signifies the cash flow of a company when not affected by secondary expenses and profits. Tax is the major factor to take into consideration here because it might cover up the real earnings of any company.
- Earnings before interests, taxes, amortisation, and depreciation: as development on earnings before interests and taxes, here the earnings are calculated after deducting the depreciation and amortisation expenses. Both of these expenses do not affect the cash flow of companies. Hence, provide a more precise picture of a company’s earnings.
Advantages of value investing
- Mitigation of risks: In this, the investors mitigate risk by investing in stocks that are undervalued and underestimated in the market. So, the investors purchase potentially fair stock at a discount. At the same time, when they diversify the portfolio, the risk is reduced further.
- Exponential returns: When done with utter “attention to details”, value investing can prove to provide investors with above-average returns. The reason is that the value investors imbibe a safety margin on their stocks.
- Low costs: with value investing, you can purchase shares which have high inherent value at power prices because of the market circumstances, do your research and bag the gold from the deep of the earth.
Disadvantages of value investing
- Long term option: one of the major disadvantages associated with this method is that the investor has to wait for several years to realise gains and profits. This investing will not provide higher profits in the short run. Therefore, investors have to lock up their capital for a considerable period.
- Time gobbling: It eats up a lot of time of the investors in research and other factors that must be considered before the investment. This can be a significant turn off for many investors. After all, digging out gems from deep fields is somewhat tricky. One has to consider various qualitative and quantitative factors.
The conclusion to Value Investing
To some inventors, value investing may seem like a slow-paced strategy. But the slower and consistent you are, the higher are your chances of sustaining in the investment world.
If you are an investor who has the golden crown of patience and stock with your investments through the high and lows of the market, then you can earn high profits and returns with this type of investing. Value investing as an approach is designed to serve the best in the long run.
If you want quick returns, then this route is not suitable for you.
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