What Value investing : Billionaire investor and his mentor Benjamin Graham both have made fortunes by practicing value investing for decades. Value understanding a simple investment philosophy does not require the investors to understand complex financial concepts. It’s very simple to understand but requires patience to practice. In this post, we discuss value investing and various issues associated with it.
Value investing – Meaning:
Value investing is an investment strategy of buying stocks trading at prices lesser than their intrinsic value. Intrinsic value is estimated value of how much actually a stock worth. Value investing believes that a wonderful stock bought at a fair price would fetch more returns than a fair stock bought at wonderful price. Value investors always try to find stocks that are undervalued in the market. When they find one, they grab it by paying the market price with a hope that it is actually wore than the price quoted in the market.
Estimating the intrinsic value:
There is no standard approach to estimate the intrinsic value of a stock. Even the same information given to 2 different investors may produce 2 different intrinsic values based on their perspective. It’s very subjective in nature. This is why the concept of margin of safety is very important while making your investment decisions. Margin of safety is the difference between a stock’s market value and its intrinsic value. Generally, stocks having more margin of safety are preferred the most.
Why do stocks get undervalued in the market?
- One of the main reasons is that most of the investors make their buy/sell decisions based on the market sentiments and the news that they hear rather than on the basis of how strong the fundamentals of a particular stock is.
- Investors tend to be disappointed when the stock they hold does not give them the expected returns within a short range of time. This makes them take decisions to sell it off in the short-run without paying much heed to the long run prospects of the stock.
- A well performing mid or small cap stock that is less known in the market without any financial media coverage may be underpriced in the market because of their unpopularity despite having good growth prospects.
- In the times of severe market crisis caused by market slowdown, the falling trend of the over-all market may induce the average investors to fear about their holdings owing to the market sentiments. This sort of fear will bring down the stock price below its intrinsic value in the momentum
- Irrational decisions of the emotional investors with less emphasis on the long-run market conditions often make the stock prices less than their actual worth.
Mindset of a value investor:
- A value investor cares much about the long-term prospects of the businesses rather than the short term setbacks that may impact the stock prices in the market.
- A value investor would always try to make profits out of the margin of safety he estimates while buying the stock than typical short-term buying/selling decisions.
- A value investor believes that the prices of the stocks in the market are not always a true reflection of their actual worth.
- They invest in the stocks the business of which they can understand. They consider future cash flows in the process of estimating the intrinsic value.
Though it looks very lucrative, value investing is not as easy as it seems. Estimating the intrinsic value of the stock is very difficult unless you have very much experience. However, one can focus on the companies with sustainable competitive advantage caring less about the stocks giving short-term windfall gains.