Say you want to experience investing in something that trades for less than their true value. By doing so, you are value investing.
The strategy of selecting stocks that are undervalued is that when companies overreact to good or bad news about the stock market, their stock goes down.
Investors then take advantage of the irrationality by buying when the price decreases, for future profit. Think about it in terms of finding bargains at a thrift shop. You are finding the best value for your buck.
Some examples include public companies that trade at discounts to book value, have low price-to-book ratios or have high-dividend yields.
Intrinsic value is a value that the stock has in terms of fundamentals or the big picture, taking into account growth, risks and possible future cash flows. It’s hard to pinpoint what stock has an intrinsic value because investors look at value differently than other investors.
What may be valuable to one may not be to another, so you have to take that into account, as well.
Benjamin Graham and David Dodd, professors from Columbia Business School, as well as teachers of different famous investors, created this strategy.
Since the 1970s, the concept of value investing has evolved, with book value, in industries where most of the assets are palpable.
Studies have shown that value investing has been/is successful with the right training and risk assessment plan. There are a number of ways to determine if the outcome of such investments is worth the risk.
- Study the performance of simple value strategies such as buying low price-to-book ratios or low price-to-cash flow. Studies suggest that by buying value stocks, they actually outperform growth stocks and market as a whole.
- Observe the investing performance of well-known value investors, such as Warren Buffett and Charlie Munger who have followed the tenets of Graham, resulting in much success.
- Determine the margin of safety, to see if the stock is really undervalued and will whether any uncertainty or market downturns-to see if the evidence is suggestive of a good investment.
- Approach the stock valuation from a business perspective. If you were to own a company, imagine a single share of stock is a piece of the ownership of that company.
- Establish if the stock is undervalued by the stock market, and that the price bears no relation to the stock’s actual worth or net access value.
- Examine what you want to accomplish, in terms of investing, and how best you want to accomplish it.
It takes some research and skill to succeed with value investing, but with the right information and education, it can actually be quite worth the risk, as so many investors have either found out, or are finding out.
Reading Benjamin Graham’s book, The Intelligent Investor, is a great first step in learning more about this potentially lucrative strategy.