Ben Waters, trader, has extensive experience of managing funds, equity trading and delta one trading. Benjamin Waters, trader, is also a value investor, having earned a BSc degree in accounting and finance from The London School of Economics and Political Science. This article will take a closer look at value investing, an investment strategy that involves investing in stocks that appear to be trading for less than their intrinsic value.
With value investing, investors focus on identifying stocks that the market appears to be underestimating. Value investors operate with the assumption that the market reacts disproportionately to good and bad news, resulting in stock price movements that do not truly reflect a company’s long-term fundamentals. This overreaction presents opportunities for profit by enabling investors to purchase stocks at discounted prices.
The world’s best-known value investor today is none other than Warren Buffett, although there are numerous others, including Buffet’s business partner, Charlie Munger; his professor and mentor, Benjamin Graham; David Dodd; Christopher Browne; and billionaire hedge fund manager, Seth Klarman.
The basic premise behind value investing in straightforward. If the investor knows the true value of something, they can achieve a healthy return by purchasing it when the share value drops to less than its intrinsic value and selling it when the price rises once more. Most people would agree that whether they purchase a new television for the full RRP or on sale, they will receive precisely the same television with the same picture quality and screen size. Stock prices work in a similar way, with share prices fluctuating even when a company’s value remains the same. This means that, strictly speaking, there is no such thing as the true value of stock of a given company, but rather there are relative values.
Stock market investors can purchase or sell shares without being bound by an objective price figure. Therefore, like televisions, stocks go through periods of lower and higher demand, triggering price fluctuations. If a company’s fundamentals remain unchanged and its future opportunities unaltered, then the value of its shares is largely the same, irrespective of share price fluctuations.
Just as savvy shoppers would reason that it makes no sense to pay the full price for a television when there are sales several times a year, astute value investors operate in a similar manner. However, unlike televisions, decreases in stock prices tend not occur as predictably as retail events like Black Friday, and their sale prices will not be advertised.
Value investing involves conducting careful research to identify these secret sales on stocks and purchasing them at a discount compared with how the market values them. By purchasing and holding these value stocks in the long-term, investors can achieve attractive yields.
In the world of stock market investing, ‘undervaluing’ occurs where stock is sold cheaply, or at a discounted rate. The goal of value investors is to generate a healthy profit by purchasing and holding shares they perceive to be deeply discounted.
Investors analyse a range of different metrics to identify the intrinsic value of stock, including looking at the company’s financial performance, profits, revenue, cash flow and other fundamental factors. Value investors study the company’s business model, target market, competitive advantage and brand, as well as analysing equity, debt, sales and revenue growth.
The origins of value investing go back to the 1920s, when David Dodd and Benjamin Graham, two Columbia Business School lecturers, coined the phrase in their book, Security Analysis. Warren Buffet, value investing’s most successful practitioner, was a student of Benjamin Graham at Columbia, learning how to identify companies whose share price is dips below its intrinsic value. Buffet describes intrinsic value as ‘the only logical approach’ to assessing the relative attractiveness of investments. Value investing is today widely regarded as a solid approach to building wealth, although it is not the only sound strategy an investor can follow.
