Among many investment strategies, value investing is one of the most popular ones. The concept of value investing was popularized in the year 1949, through Benjamin Graham’s book ‘The Intelligent Investor’. This book can be considered as the bible for value investors and the most successful investors including Warren Buffett swear by its principles.
Here, investors look for stocks that are generally undervalued and are trading below their intrinsic value. Value investors use several financial ratios that help them understand the health of the company and gives an idea about their future growth potential.
How does value investing work?
Investopedia states if you know the true value of something, you can save a lot of money when you buy it on sale. This is the basic concept applied by value investors whenever they identify stocks for their portfolio. It is very difficult to find quality undervalued stocks in the market today but if you keep looking, you will get plenty of opportunities to enter the market at the right time.
This is because the market is volatile and often reacts on news. For example, the massive disruption in crude oil prices led to a significant fall in stock prices of energy companies. While oil producers did experience a year-over-year decline in revenue in the first six months of 2020, midstream players such as Enbridge (TSX:ENB) have been largely immune to the same.
So, it is quite possible that the correction in Enbridge stock would have been exaggerated and the large cap stock is now trading at a lower multiple. While most traders may look at this as a sell signal, value investors look at Enbridge’s stock price decline as a buy signal because they look at a different set of parameters that impact the company’s overall performance.
Value investors believe that markets are inefficient and fluctuations are common in equity markets. Value investing requires patience and most successful investors including Warren Buffet have managed to create wealth over the past few decades by purchasing stocks trading at a discount.
Why does value investing makes sense?
Stock markets are uncertain and value investing teaches you to embrace this uncertainty rather than view it as a negative impairment. Every major stock market correction throws up multiple buying opportunities that can increase your investment multifold over time.
Value investing works for those who understand that the price and value of a stock are different. Value investors tend to focus on the company's buisness model, its economic moat and the company’s total addressable market among other things. This paired with the fundamentals of the company leads a value investor to invest in a good stock.
Value investing is not easy and for an investment to work out, it takes a lot of time and patience. According to wealthofcommonsense, investors prefer the glamour growth stocks provide and because of this bias, cheap stocks are often overlooked. Value investing may not give you fast returns but you can outpace the broader market over a period of time.