Who isn’t fond of a good bargain? But a bargain does not necessarily mean getting things for cheap and ignoring quality; rather it is deriving utility from the money spent. Same is the case with value investing. It is not merely buying stocks at a discount but buying underpriced stocks that have an intrinsic potential to give big returns in the long run.
The value investing strategy focuses more on the fundamentals of the business and the company rather than the external influences on the stocks price. External influence is not so important in this case as markets overreact to good and bad news, resulting in stock price movements that are not in sync with the company’s fundamentals.
Benjamin Graham is considered as the father of value investing. He along with David Dodd, both professors at Columbia Business School, advocated the concept of Margin of Safety which is the cornerstone of value investing. This concept was first introduced in Security Analysis, a book co-authored by them in 1934. Margin of safety is the difference between the market price and the calculated (intrinsic) value of the stock.
While value investing is an opportunity for investors to profit by buying the stock when it is underpriced, it is not just laying your hands on every undervalued stock in the market. One has to consider several factors to judge the underlying value of the stock. Important stock indicators considered for value investing are price to earnings (PE) ratio, price to book value (PBV) ratio, PE to projected growth in earnings ratio or PEG ratio, and dividend yield.
While for dividend yield, the higher the number the better it is, for the remaining factors, the lower the number, the better it is.
Besides, when it comes to value investing, the importance of analysis cannot be overemphasised. Significant analysis must be done prior to investing such as reconciling market value and book value as well as estimating intrinsic value. This is important as investments are necessarily for the long term. One has to be on top of the market to rightly determine what is causing the gap in price and value of the stock.
But all investors are not equipped to handle the analysis on their own. Investing is an art, more so in equities, due to its inherent volatility. To avoid making a wrong decision, investors can choose the mutual fund route for investing in value