Value investing in a bit like modern art. Everyone gets the general idea (squiggly lines, colours, nibbling on tiny cocktail sausages while you talk about it). But what’s good and what’s bad? What defines exact values? What’s the best way to make it? Same goes for value investing. In this article, The Motley Fool takes a balanced look:
What is Value Investing?
Someone once asked me what the best style of investing is. Truth is there are many different investing styles. Some investors like the idea of receiving regular income from their shares. Therefore they may target shares that could deliver dependable dividends into their portfolios.
Other investors prefer to invest in shares that could grow faster than the market. Hence, they are more interested in looking for shares that have growth potential rather than pay out dividends.
There are also blue sky investors. These investors believe they have the skill to identify the next big thing. Then there are value investors who trawl the markets for mispriced shares. Value investors are very clear in their approach to investing. They assume that over the long-term, a share should more or less reflect the intrinsic value of the company.
A well worn analogy was provided by Benjamin Graham who is recognised as “the father of value investing”. Graham once said that in the short term, the stock market is a voting machine….but over the long run, it is a weighing machine. In other words, Graham believed that while value shares may be discounted by the market now, they could go up in price when the true value has been recognised.
Interestingly, value investing is sometimes compared against growth investing as being polar opposites. However, the distinctions are largely academic. That’s because growth investors don’t buy shares because they think they may be overvalued. And by the same token, value investors don’t buy shares because they think they won’t grow.
However, value investors do insist on buying companies whose share price is significantly below their intrinsic values. In other words they are looking for a good margin of safety even if it means sitting on their hands until the price of a great company falls into an acceptable range. Consequently, value investors rarely follow the crowd. If anything they tend to invest against the market, which is why they are sometimes referred to as contrarian investors.
How Value Investors Do It
Some value investors try to only buy shares that have margins of safety of 50% or more relative to their intrinsic value. What’s more, when the stock approaches its intrinsic value, they sell and repeat the process. Other value investors might look for a significant margin of safety but are also willing to pay more for established companies with durable competitive advantages or moats. They believe that in the long term, those wide moats translate into compound market-beating returns.
In all of these cases, however, the value investor is looking to firstly estimate the intrinsic value of the company. Then they judge the stock price against the intrinsic value. And they will only buy when there is a reasonable margin of safety.
Regardless of your investing style, The Motley Fool’s purpose is to help the world invest, better. Click here now for your FREE subscription to Take Stock — Singapore, The Motley Fool’s free investing newsletter. Written by David Kuo, Take Stock — Singapore tells you exactly what’s happening in today’s markets, and shows how you can GROW your wealth in the years ahead.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.
Image Credits: StockMonkeys.com
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