The core essence is buying stocks with strong fundamentals that are trading at discounts to their book value, have high dividend yields and low P/E ratio. Since its inception, value investing has taken many forms, as Warren Buffet argued that the core of value investing is buying stocks less than their intrinsic value.
In long term, the share prices reflect the intrinsic value but in short/medium, term share prices are rather above or below it. Value investors do not believe in the Efficient Market Hypothesis and seek to make the most out of this disparity. If an investor is looking to beat the market, then he should consider a proven strategy by famous investment greats like Warren Buffet, Benjamin Graham, David Dodd, Christopher Browne, and Charlie Munger. Before an investor considers value investment as his thing, he must understand few fundamental concepts.
Fundamentals of Value Investing
The first basic concept is that every share has its intrinsic value, and the fluctuations in share price are caused by periodic higher and lower demand but the underlying true value of the share does not change. Hence, the concept to understand here is the price of a share can vary even when the intrinsic value is unchanged. In addition, the principle of Margin of Safety is a key to successful value investing; buying stocks at discounted prices gives an investor a fair chance to earn profit in the future.
In addition, it makes investors less vulnerable to huge losses. For example, if one purchases a branded watch for $20 from the street vendor instead of buying at the full price of $100, you will lose only $20 if it comes out to be fake. If he had paid the full $100 earlier then it would have faced a big loss.
Efficient Market Hypothesis
The next concept is those value investors do not believe in the `Efficient Market Hypothesis’ which says the stock price reflects all information about the company. The value investors believe that stocks are over or underpriced sometimes in short term due to changes in investors’ psychology, momentum swings in the market, or some new technology that has not been proven yet like the dot com bubble.
Value investors do not follow the herd, they do not buy when everyone is buying, or sell when everyone is selling. They rely on the valuation of the company and only care about the company’s intrinsic value. Lastly, value investing requires patience and diligence, it is a long-term strategy, and investors should not expect to see results in days or weeks. Value investing is like an art form, one should stick to his investment philosophy even though one loses money occasionally.
Growth Stocks Vs Value Stocks
NEW YORK, October 17 (FinanceEnquiry.com) – It has long been a debate among investors, money managers, and various other financial bodies and institutions as to which style of investment is successful. However, none of them were able to produce any evidence that would put the matter in the grave. Both the styles have outperformed each other at various points in time. The fact is sometimes value pays off best, other times growth does, but it is subject to market trends. It is been observed that growth investing performs better in bull markets whereas value does well in the bear market.
Growth stocks are usually expensive and are overvalued; on the other hand, value stocks tend to trade at lower prices compared to their fundamentals. Value stocks possess strong fundamentals but they are fallen out of favor of the market. Investors believe, if they buy at discounted prices below their fundamentals, they may increase in value in the long term.
Characteristics of Value Stocks
In order to classify a stock as a value stock, it must fulfill the basic criteria like:
- Value stock must have a low P/E ratio and should not exceed 10% of the lowest observed in the companies of the same industry.
- The price to earnings growth ratio should be less than 1, in order to be sure if the stock is a value stock.
- The value of equity should be approximately equal to the debt.
- The liabilities should be half of the total assets of the company.
- The price per share of the stock should be less or equal to the tangible book value.
The above are just the basic criteria to see if a stock is a valuable one. However, there are many other criteria and it changes from investor to investor. Growth investors look for the companies with fast-growing successful companies with growing earnings. Investors who purchase growth stocks benefit from future capital appreciation, rather than dividends.
Characteristics of Growth Stocks
In order to classify a growth stock one should look for the following signs as mentioned below:
- Considering big companies are to grow slowly as compared to small companies in long term, we should look for a growth rate of 10% for small companies and 5-7% for big companies for the previous five years.
- Growth stocks present solid Return on Equity (ROE) when compared with their peers in the same industry.
- A sound EPS (Earning Per Share) is necessary for a growth stock, and one must pay detailed attention to pretax profit margins.
While evaluating a growth stock, one must see if it fits the basic criteria, and use common sense to make reliable decisions. Both the approaches whether it is valuable or growth investing, none guarantees to provide profits and carry investment risks. The return and principal value of stocks fluctuate with market conditions. Irrespective of the type of style you prefer, you may want to use both investing techniques for a diversification strategy that may help in managing risks and enhance your returns over time.
Three things to remember before investing in the stock markets
There are few basic points that you need to know before initiating investment in stock markets. Stock exchanges are commercial trading platforms for organizations and investors. In the stock market, trading of company stocks and derivatives of stocks usually takes place. There are basically three things to remember before investing in the stock market, as mentioned below:
- Select the ideal stock considering market conditions
- Spread investment across stocks and markets
- Monitor the right information provider
Stocks from different corporations remain listed on stock exchanges. Mainly, it is the corporations and mutual fund providers that trade within the stock market. In a stock market, buyers and sellers of stocks come together with the purpose of trade transactions. The stock market index undergoes fluctuations, which means the price volume of stocks can rise up and go downhill. It is advisable not to buy just one kind of stock; instead, it is better to buy stocks of companies from different industry segments. Seasoned investors buy stocks across different sectors as well.
While investing, it is essential to know where one’s money is involved. So, regular study and analysis of the future prospect of different trading companies can place you in a better condition. To know the market trends better, you should find popular online newsletters. There are many online portals that offer instant market news and the latest trends.
Three things to remember before investing
Among the three things to remember before investing in the stock markets, it is important to analyze where the money can be invested. So, before investing, you need to have a clear overview of the leading stock trading platforms. In the United States, the NASDAQ, the New York Stock Exchange (NYSE), and the Amex are the main stock exchanges. Besides these, there are several other regional exchanges like the OTCBB and the Pink Sheets.
In Europe, the Paris Bourse (presently an official part of Euronext), LSE or London Stock Exchange, and the Deutsch Bourse are most significant. In Asia, BSE (Bombay Stock Exchange), TSE (Tokyo Stock Exchange), Shanghai Stock Exchange, SGX (Singapore Exchange), and KLSE (Kuala Lumpur Stock Exchange) are popular trading platforms. Once you are well aware of the stock markets and the available stocks, you can make better investment decisions.
Information is the key to success in stock trading.
There are many business news channels and web portals that bring out the latest news from stock markets. After you identify a reliable information provider, it will become easier to handle the stocks. The mode of investment, whether you select commodity stocks, penny stocks, gold stocks or real estate stocks, etc. will depend on the market trends. So, it is one of the three things to remember before investing in the stock markets; ideally, you have to know the latest trends of the markets to invest intelligently.
For novice investors, it is best that they go through the online articles and journals to have a clear vision of the markets and the corporations that are trading with them. Then, it is better to focus upon the companies that will provide better returns. For effective stock selections, it is best to rely upon online newsletters, printed financial newspapers and television business news.