Value investing is an investment strategy in which investors seek undervalued stocks or trade less than their intrinsic value. Though value investing has different types of execution based on the individual, several general principles are common to every value investor. Investors like Warren Buffet, Kenneth Fisher, and Peter Lynch have shared several principles. Below, we will discuss some of these top value investing principles. Let’s begin.
Be Adept at Fundamental Analysis
Fundamental analysis is crucial in value investing. As a value investor, study your target company’s earnings, financial statements, balance sheets, cash flow, and business fundamentals. Examining these factors allows you to know a company that trades close to its intrinsic value, indicating a good investment potential.
Seek Well-managed Companies
Management is crucial in every company. Good management goes beyond the hard assets since poor management can harm a company’s solid financials. Many investors base their investment strategies on seeking able and honest managers.
As a value investor, you seek a manager who acts like an owner. Top managers ignore a company’s market value. Instead, they focus on growing the business and creating long-term shareholder value. On the other hand, managers who act like employees will focus on short-term earnings so they can theoretically get bonuses or other performance perks, and this could sometimes be detrimental to the company.
Consider an Investment in a Company with a Safety Margin
The margin of safety refers to the difference between the price of a stock and its intrinsic value. A large margin of safety means you have more protection if your value assessment is wrong. Let’s take an example. If you think a particular stock should have a price of $1000 and buy it for $900, you have a 10% safety margin, which isn’t a wide margin for error.
When buying stocks, the best stocks usually offer a large margin of safety. Choose the lowest margin of safety for your intended value stock. You can begin at 20%, then adjust it down or up as you improve. You can use this calculator to estimate the intrinsic value of a stock.
Don’t Make Emotional Decisions
You must be careful of emotional decisions as they make you perform market extremes. Fear drives market crashes, and greed drives stock market bubbles. Therefore, it is essential to remain calm and resist herd behavior. Value investing frequently needs contrarian thinking. Most times, the herd is caught in the hype and trends, but value investors search for opportunities that others often overlook.
While this is easier said than done, it is helpful to note that you can also find some gains in market extremes. Conversely, following the herd can increase your chance of buying high and selling low. However, this isn’t a sustainable investment formula.
Be Patient and Long-term
Repricing an undervalued company doesn’t happen instantly. It takes years. You must understand this important truth: you need patience for value investment before you buy or after. When you get a prospective value stock, you might need to wait till a market downturn brings the stock price down to the margin of safety that meets your requirement. After buying a stock, you might also need to wait years before seeing the expected value.
However, the good news is that value stocks can withstand the test of time, and there is no deterioration in the company’s fundamentals.
Endnote
When value investing, it is important to note that you require a long-term mindset. Your timing might occasionally be lucky, and your investment might pay off quickly, but a value-focused strategy is not a guarantee of quick gains. Value investing strategies take time, but the effort and time you spend on them are worth it.