An Introduction to Value Investing

Value investing is much more than buying cheap companies. It’s about finding stocks that the market has not correctly priced.

Value investing is a style or strategy that involves buying stocks that are currently trading at less than what the stock should be appropriately valued at, its intrinsic value. Some consider value investing to be a contrarian investing style which favors good stocks at great prices over great stocks at good prices. Value Investing starts with determining the intrinsic value of a stock, and buying if the difference between this value and the stock price offers a sufficient “margin of safety”.

Developed by legendary Wall Street wizard Benjamin Graham, mentor of Warren Buffett, value investing strategies are thought to be the most reliable and successful approaches for investing on Wall Street. Graham proposed that the foundation of sound investing should be adhered to and altered only as a result of important economic and financial changes.

While Benjamin Graham introduced value investing, savvy stock market pros like Warren Buffett have practiced Graham’s principles to filter out undervalued stocks and uncover hidden winners at relatively low risk. Even though value investing has taken many different forms since its original inception, it normally involves purchasing securities which have shares that appear as if they are under-priced by conducting fundamental analysis on those companies.

The challenge with value investing is that no one formula perfectly captures a business’ value, but fundamentals, such as earnings growth, dividends, cash flow, and book value are important factors. If the fundamentals are sound and the stock’s price is below its intrinsic value, the value investor knows this is a likely investment candidate. When the market corrects (as it tends to over the long-term) the stock’s price should rise. The idea is to locate stable stocks that are undergoing a temporary fall in unit price, but are still considered to be good risks for future growth. Most value investors like to target companies that have shown consistent profit for the past three to ten years.

In determining intrinsic value, the price of a stock (just like the price of any other financial instrument) should equal the present value of its future cash flows. If it is a stable, profitable business with a competent management team available at an excellent price, then it may present a good investment opportunity.

Value investing is simply investing in a company whose shares are temporarily trading at lower prices than their true worth. It is a buy and hold strategy that involves waiting for the stock price to turnaround. Value investing and growth investing are two of the best known stock-picking methods.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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