Investing allows you the opportunity to earn significant rates of return, which can increase your financial worth over time. Whether your goal is to send your kids to college or to prepare for a retirement plan, it’s never too late to become an investor.
Although risk cannot be totally eliminated, it can be hedged by diversifying your portfolio across different financial instruments, categories, and economic sectors. Following the value investing principles, long-term investments help you reach long-range financial goals while minimizing risk.
What is Value Investing
Value investing is an investment paradigm that focuses on buying undervalued stocks of companies with long-term growth potential and holding them over a long period of time. It is different from buying “cheap” shares or purchasing the bargain bin for discontinued models. Instead, it involves finding stocks that are worth more than their current price in the market.
In a nutshell, value investors can gain cash flow and dividend by purchasing securities that will trade well below their intrinsic value or the companies “true value” post in-depth and complete analysis. This clever approach to investment allows many investors to develop a substantial amount of wealth while minimizing the risk of long-term losses by analyzing companies on a holistic approach.
Value Investing Principles:
Value investing is most suitable for individuals who want to diversify their portfolio and are willing to patiently remain invested with their stocks without being carried away by their emotions and the daily and short-term movements of stock prices. Listed below are some of the most important principles of value investing that you should know:
SPECULATION IS DIFFERENT FROM VALUE INVESTING
The main difference between speculating and value investing is the amount of anticipated risk involved. Speculation is a method of short-term investing that has a substantial risk of losing most or all your invested capital, but with the expectation of a significant gain. Speculative investors purchase or sell stocks with a “hunch” that their directional investment will come to fruition.
MARGIN OF SAFETY
The safety margin is the difference between the break-even point and the expected amount of profitability. Since the fundamental part of value investing is to buy a stock when its price is not equal or lower than your calculated fair price, having a safety margin provides a buffer to absorb sales volatility and it also serves as a cushion against errors in calculation.
As title suggests, value investors seek to appraise the value of a stock compared to its current reflected / traded price. This involves two main concepts: undervalued stocks and overvalued stocks. Certain stocks are perceived to be undervalued when the current trading price is lower than its intrinsic value. While an overvalued stock has a current price that is not justified by its P/E ratio or earnings projection and various other factors.
Before making key decisions, investors should first look into the three (3) main financials of the business, such as the balance sheet, income statement, and cash flow statement to have a comprehensive look at the performance of the company in the previous quarter or year. When analyzed in detail and taken in context, these official company records will provide value investors with significant assistance in making sound decisions.
Value investing is not a get-rich-quick scheme, but a long-term strategy that works well when done right. Even though it won’t make you rich right away, it will allow you to gain substantial amount of money and equity in the companies you invest in. The key here is to extend your patience in a longer time horizon, rather than switching back and forth after the tide turns in the market.
Benefits of Value Investing
One of the main advantages of this type of investment is it benefits from lower downside risk and far lesser volatility as compared with other stock investing strategies. Unlike short-term investment strategies, this allows you to reinvest your dividends allow profits to compound over time and continue to work for you. The long horizion benefits of compounding is that even the smallest amount can drastically grow and allow you to earn high returns when given enough time. Alternatively many companies enter into “buy back” programs. As a company acquires back outstanding shares, current shareholder in effect hold a large stake in the company. In theory, the price of the equity or stock should go up and dividends for current shareholders should also go up. In the end, your patience will be rewarded and you will enjoy solid returns that will contribute greatly to your long term success.
Greatest Value Investors
Legendary investor, Warren Buffett is an inspiration to investors across the globe. Buffett’s investment strategy involves focusing on companies as a whole, instead of following the supply and demand intricacies in the market. Other considerations for value investors like Buffett include company profit margins, company debt, company performance, how cheap they are, and how reliant they are on commodities. Ironically, the man carries a humble demeanor with a grandfatherly approach to investing that has outperformed everyone in the field of investing.
Billionaire hedge fund manager, Bill Ackman leads the list of today’s most successful value investors. His investing philosophy involves buying common stocks of public companies and pushes for changes in order to make the market realize the value of these companies. He often goes for businesses that are simple, resilient, sustainable, and free-cash-flow generative. The core point here is to choose businesses with high barriers of entry, where it’s going to be difficult for other entrepreneurs to compete with the business.
Carl Icahn made his billions of fortune as a corporate raider by purchasing large stakes and pushing the company in so many ways to unlock value and realize its full potential. His strategy involves hunting companies with share prices that reflect poor P/E ratios and investing a significant portion of the equities of those companies. In one of his interviews, Icahn said that his investment philosophy generally revolves around buying shares of a company when no one wants it. At 80 years old, he is worth $16.3 million and is considered one of the best value investors in the world.
Benjamin (Bill) Graham, the father of value investing has pioneered cutting edge investing concepts that attribute to many of today’s most successful business people, including Warren Buffett. In his book, “The Intelligent Investor,” Graham shares a great deal of wisdom that is applicable to both passive and active style of investing. The key takeaway of this book is to look for no brainer opportunities and purchase stocks that are clearly underpriced in the market. Following Graham’s investment methodical approach will guarantee that the stock market is a level-playing field and not one with hidden land-mines.