Hi Friends, Welcome back to share market mind.Today we are going to discuss about value Investing So we start discuss now.
What Is Value Investing?
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value. Value investors actively ferret out stocks they think the stock market is underestimating. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond to a company's long-term fundamentals. The overreaction offers an opportunity to profit by buying stocks at discounted prices—on sale.
Warren Buffett is probably the best-known value investor today, but there are many others, including Benjamin Graham (Buffett's professor and mentor), David Dodd, Charlie Munger, Christopher Browne (another Graham student), and billionaire hedge-fund manager, Seth Klarman.
Important point
• Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.
• Value investors actively ferret out stocks they think the stock market is underestimating.
• Value investors use financial analysis, don't follow the herd, and are long term investors of quality companies.
How Does Value Investing Work?
The principle behind value investing is purchase stocks when they are undervalued or on sale, and sell them when they reach their true or intrinsic value, or rise above it. Another condition which value investors follow is allowing for a margin of safety when trading in value investing stocks.
Stock prices can change owing to several reasons, underlined by a popularised market tendency which causes a share’s price to waver from its intrinsic value.
For instance, if as per popular market belief Company A will perform extremely well in the future, its share prices might increase from Rs. 100 to Rs. 120, further influencing the market into raising its demand and price dramatically from Rs. 120 to Rs. 180. However, upon inspection and proper analysis, it is found that the company has an average financial and organisational structure which does not withstand such high expectations. Thereby, its intrinsic value is determined at Rs. 80, which means it is overvalued by Rs. 100.
Top value investors refrain from partaking into such market tendencies and ferrets for stocks of companies that have sound long-term fundamentals. Still, due to several contributing factors, their prices are lower than their inherent value.
IMPORTANT : Value investing developed from a concept by Columbia Business School professors Benjamin Graham and David Dodd in 1934 and was popularized in Graham's 1949 book, The Intelligent Investor. |
Intrinsic Value and Value Investing
In the stock market, the equivalent of a stock being cheap or discounted is when its shares are undervalued. Value investors hope to profit from shares they perceive to be deeply discounted.
Investors use various metrics to attempt to find the valuation or intrinsic value of a stock. Intrinsic value is a combination of using financial analysis such as studying a company's financial performance, revenue, earnings, cash flow, and profit as well as fundamental factors, including the company's brand, business model, target market, and competitive advantage. Some metrics used to value a company's stock include:
Price-to-book (P/B) or book value or, which measures the value of a company's assets and compares them to the stock price. If the price is lower than the value of the assets, the stock is undervalued, assuming the company is not in financial hardship.
Price-to-earnings (P/E), which shows the company's track record for earnings to determine if the stock price is not reflecting all of the earnings or undervalued.
Free cash flow, which is the cash generated from a company's revenue or operations after the costs of expenditures have been subtracted. Free cash flow is the cash remaining after expenses have been paid, including operating expenses and large purchases called capital expenditures, which is the purchase of assets like equipment or upgrading a manufacturing plant. If a company is generating free cash flow, it'll have money left over to invest in the future of the business, pay off debt, pay dividends or rewards to shareholders, and issue share buybacks.
Of course, there are many other metrics used in the analysis, including analyzing debt, equity, sales, and revenue growth. After reviewing these metrics, the value investor can decide to purchase shares if the comparative value—the stock's current price vis-a-vis its company's intrinsic worth—is attractive enough.
Best value investors use these metrics and factors to determine whether a company qualifies as undervalued.
Advantages of Value Investing
Risk minimisation
In general, investing in equity shares is associated with high risk due to its correspondence with market fluctuations. However, with value investing, investors mitigate that risk by earmarking stocks that are undervalued, and thus, can purchase potent shares on sale. Eventually, these shares would reach their intrinsic prices or maybe go higher, which would allow them to earn substantial capital gains.
Investors of this category use margin of safety to attenuate the associated risk. It means purchasing a share when its prices are lower than a particular limit. Thus, even if they are wrong about a specific company, losses, if any, would not be significant. Benjamin Graham, for instance, only purchased stocks when their prices were 2/3rd of the intrinsic value.
Substantial returns
Value investing, if done accurately, can fetch above-average returns in the long-term. It is because investors employ a margin of safety, elaborated above.
For instance, if an investor purchases stocks of a company at Rs. 70/share when its intrinsic value is determined at Rs. 100/share, he/she stands to earn Rs. 30/share by selling it when the stock returns to its intrinsic value, and even higher if share prices go above its intrinsic value.
Disadvantages of Value Investing
Long-term investment option
One of the primary disadvantages of value investing is that it does not provide higher returns in the short-run and thus compels investors to lock their capital for a considerable period.
Time-consuming
Value investing online or offline consumes a significant amount of time as investors have to dedicatedly seek out companies that are undervalued by using several qualitative and quantitative fields.
Strategies for Value Investing
The key strategy to invest in undervalued stocks is by using the metrics mentioned above, such as EBDITA, EBIT, P/E ratio, etc. Investors who are willing to adopt value investing need to properly analyse a company and derive its intrinsic value to realise substantial profits and minimise risk.
An additional approach is seeking out companies that have assets which are not properly reflected in their balance sheet. Such assets include intellectual property like patents. Their value might increase in the future owing to market conditions, which causes stock prices to rise dramatically.
Difference between Value Investing and Growth Investing
Value Investing | Growth Investing |
•Investing in companies that are undervalued in the stock market. | •Investing in companies that have generated higher than average returns in current times. |
•Value stocks trade at a low or •discounted price | •Growth stocks trade at a high price |
Low-level of risk. | •High-level of risk. |