What is Value Investing

What is Value Investing

Choosing stocks that appear to be trading for less than their actual or book worth is called value investing. Value investors aggressively seek stocks that they believe the market undervalues. They think that the market overreacts to both positive and destructive news, resulting in stock price swings that are out of line with a company’s long-term fundamentals. The market’s response provides an opportunity to benefit by purchasing stocks at a sale discount.

Value investing is known as buying stocks that sell at a significant discount to their intrinsic worth. Value investors do this by looking for companies with low valuation indicators, such as common multiples of profits or assets, for reasons that aren’t sustainable in the long run. This strategy necessitates a contrarian attitude as well as a long investment vision. A value investment strategy has consistently outperformed index returns across several equity markets over the previous 100 years.

Value Investing

Benjamin Graham’s Four Pillars of Value Investing

MarketAssume you’re in a joint venture with Mr. Market, where you can purchase and sell stocks. Mr. Market offers you share prices each day based on his mood. Mr. Market will give exceptionally high pricing if he is in an upbeat mood. In this instance, a shareholder should sell their stock. Mr. Market will give reduced pricing if he is in a negative attitude, and this is the time to buy.

Intrinsic Value

The intrinsic value measures a company’s intrinsic value based on its fundamentals. Because of shifting market attitudes, market prices diverge from their fundamental importance in the near run. Market prices tend to return to their intrinsic values in the long run. Because we can buy equities when their actual values fall below their current levels, this technique allows us to benefit. We keep them till their intrinsic values are restored in the long run.

Margin of Safety

The essence of valuation is the margin of safety. There is a risk of excessively optimistic when estimating intrinsic value because it involves subjective evaluations. By adjusting the optimism from the forecast, the margin of safety provides a buffer. Assume that your inherent value estimate is Rs 100. You can change the value to Rs 80 if you take a 20% margin of safety into account. You will not overpay for any asset if you do this.

Investment Horizon

Long-term value investing works because prices eventually return to their intrinsic value. The goal of value investing is not to predict what stock prices will do in three days or three months. Instead, it seeks out inexpensive companies that will outperform over time. The stock price will eventually reflect this.

The Four-Filter Approach to Value Investing by Warren Buffet

Warren Buffet’s four-filter method to value investing is a more advanced version of value investing. It is a method of arriving at an investment decision while considering qualitative and quantitative value investing aspects.

The method identifies businesses by completing the four procedures below:

Identifying the Competence Circle

It entails identifying all of the companies you are familiar with and having a solid understanding.

Value investors must invest exclusively in companies that they understand. Value investors must concentrate primarily on industries where they believe they have a competitive advantage over the average investor.

Similarly, avoiding away from things you don’t comprehend is crucial.

A Moat to Keep Your Castle Safe

When we look at the castles, we see that a deep moat surrounds them. To keep attackers/enemies at bay, this moat was usually filled with water and crocodiles or other carnivorous reptiles. It would help if you looked to safeguard your fortress in value investing.

Said, you should seek out organizations that have a long-term competitive advantage. The more significant the edge, the wider the moat. This moat would keep competitors out of the firm.

And if the company can use its competitive edge to enlarge the moat gradually, it is the ideal business to be in. Companies with extensive moat can generate higher profits for their shareholders. They can do it year after year, year after year. As a result, its expected stock value rises.

Management that is Capable and Trustworthy

Management is maybe the most significant of the several elements to consider before investing in a firm.

Management that is capable and trustworthy continually exhibits competence and works in the best interests of shareholders.

When evaluating management, there are three primary things to consider:

1. The company’s achievements
2. The way the company’s stockholders are treated
3. How skillfully it manages the capital allocation

A Reasonable Price

Finally, a reasonable price tag for stock selection is nothing more than the previously mentioned margin of safety. It entails determining the company’s genuine market value per share using a variety of methodologies.

Value Investing Ratio

You can also use other stock-specific valuation ratios while selecting value investing stocks.

Two of these most common ratios are price to earnings ratio (PE ratio). The other is the price to book value ratio (PB ratio).

Price to Earnings Ratio (PE Ratio)

Price-to-earnings (P/E) compares the stock price to the company’s earnings records to see if the stock is overvalued or undervalued. The cost-to-earnings ratio (PE ratio) compares the stock price to the earnings per share of a company.

PE Ratio = Price per Share/Earning per Share

Example- Bajaj Auto Example

• Current Stock Price Rs. 3135
• Earnings per Share Rs. 134
• PE Ratio= Rs.3135/Rs.134= 23.4

Price to Book Value Ratio (PB Ratio)

Price-to-book (P/B), often known as book value, is a ratio that compares the worth of a company’s assets to its stock price. The stock is undervalued if the price is less than the value of the assets, assuming the company is not in financial distress.

Example- Bajaj Auto Example

PBV Ratio = Price per Share/ Book Value per Share

• Current Stock Price Rs. 3135
• Book Value per Share Rs. 598
• PBV Ratio= Rs.3135/Rs.598= 5.32

What is Value Investing

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