There are many ways to invest your money. Whether you adopt it or not, one investment approach you should know about is called value investing.
This is a smarter approach than just sitting hunched in front of your computer for hours each day, nervously watching the markets. Value investing also offers higher returns than investing a consistent amount of money every month into an ETF, and then leaving it there for the long term, a practice known as dollar cost averaging.
But is value investing worth doing in Singapore?
What is value investing?
The basic principle of value investing is very simple: buy low, sell high.
Value investing operates along the belief that companies have an “intrinsic value”. This is how much they’re worth based on the value they are creating.
But this value is not always reflected in stock prices. When a stock is priced below what the company is intrinsically worth, that means it is undervalued.
The opposite can happen as well—stock prices can also rise above the company’s intrinsic value, which makes them overvalued. However, the danger of buying overvalued stocks is that at some point, the bubble will burst and the stock price will tumble when investors realise the company is not delivering.
So why do stock prices deviate from the company’s intrinsic value? That’s because they are sensitive to factors other than the company’s performance, such as investors’ sentiments and the economic climate.
As a value investor, you want to look for undervalued stocks and later sell them at a profit. You want to invest in companies that are soundly run and financially healthy, but that investors have somehow overlooked.
Who is value investing suitable for?
Value investing is versatile in that it can be both a long-term or short-term strategy.
If you have the time and patience to monitor every little fluctuation in the market, you can buy and sell your stocks at a much faster rate.
At the same time, value investing isn’t any less of a long-term strategy than dollar cost averaging. It can take years for stock prices to rise to better reflect a company’s intrinsic value. If you’re not going to monitor the markets daily, you can hold on to your investments for the long-term.
Like all types of stock investment, there is a certain degree of risk. So value investing may not be for you if you have a low risk tolerance. For instance, if you are planning to retire in three years’ time and will need to liquidate your investments soon, it is probably a better idea to put them in lower risk vehicles like bonds or deposits.
However, if you have a medium risk tolerance and are also able to wait years for your stock prices to rise, value investing can be very rewarding in the long run, and also yield higher returns than dollar cost averaging.
What are the methods value investors use to decide what to buy?
While the basic concept of value investing is very simple, actually trying to figure out which stocks are undervalued or overvalued is the hard part.
Value investors use a variety of methods to analyse stocks. Some investors rely on Excel spreadsheets and complicated formulae, while somewhere out there there is a guy buying stocks on the advice of his feng shui master.
Broadly speaking, we can classify value investing approaches into two categories:
Quantitative methods: Focus on the business’s potential in the long-term, including factors like how well it is managed, and how it is using its finances. This is very difficult to get right and requires a lot of experience and knowledge.
Qualitative methods: Focus on the business’s current strength vis-a-vis its stock price. Evaluating the business’s state can be simply a question of analysing its historical stock prices. For most laymen, qualitative methods of analysis are the most practical.
Some investors also aim to select undervalued companies that pay out regular dividends so that they get some passive income at the same time. This is a popular strategy amongst older investors who are closer to retirement.
As you can see, value investing does add an additional layer of complexity that is not seen with dollar cost averaging. However, you certainly do not need to know every single thing about a company if you use a qualitative method to evaluate stocks. And for many investors, the extra time spent analysing stocks is certainly worth it if it means higher returns.
Are you a value investor? Share your tips in the comments!