Benjamin Graham and David Dodd introduced the concept of value investing in the 1920s. Warren Buffet, Charlie Munger, Michael Burry, Seth Klarman, and Joel Greenblatt are just a few of the renowned investors who have adjusted and improved the original value investing techniques over the years.
The moment we think of some of the most famous investors listed above, who have been involved in value investing, we might wonder what value investing is actually all about. According to the definition of value investing, that is an investment approach whereby investors look for companies whose stocks are trading at a discount. Accordingly, the stock’s current market value is less than its intrinsic value. For more information, go to theory-a.com.
Be aware of the investment’s intrinsic value
Stock price movements are what most investors rely on when buying and selling investments. Over the long term, value investors generally believe that a stock’s price generally reflects its value, which is its intrinsic value.
Thus, there may be a case for buying stock at a discounted price if a stock’s price is below its intrinsic value. It is possible to estimate an intrinsic value of a stock in a number of ways.
High Safety Margin
In order to define the margin of safety for a stock, we need to understand how the price of the stock contrasts with its intrinsic value. For example, if the stock is currently trading at Rs. 100 and its intrinsic value is Rs. 95, then the margin of safety for the stock is 5%.
Earlier, I discussed how an intrinsic value is calculated for a stock by using various factors, such as historical information about a company, its competitors, and the industry in which the company operates. In addition to the assumptions used for this calculation, some key assumptions concerning the company’s future may also be incorrect, causing errors. An investor’s safety net or cushion is increased when there is a high margin of safety.
Investing for the long-term is the best strategy
Sometimes, a company’s intrinsic value can take time to show up in its share price. The reasons for this can be the state of the economy, the fact that the investment is in a declining sector, etc.
Value investing requires practitioners to wait patiently for the market price of a stock to match its intrinsic value because the price can take many years to match. Investors who wait for the stock to rise in value allow markets to recognize the stock’s actual value. We are constantly bombarded with the latest updates and trends from around the world, so it is a bit difficult to be patient and wait for these developments to take place.
The herd does not always lead the way.
A value investor may not be the best choice if they prefer to go with the flow or practice momentum investing. When investors turn their attention elsewhere, stocks become undervalued, and this has historically been the case quite often.
Investing in energy, technology, and pharmaceuticals was the most popular sector in 2020, for example. In the period between 2015 and 2019, these sectors were the most ignored multiple times.
Consequently, good value investors have to be able to ignore the noise. Through this method, one can buck the trend and choose investments no one else is considering.
A successful value investor should not follow a herd mentality because value investing requires picking investments carefully. In order to succeed as a value investor, it is also necessary that they be patient, not engage in speculation, and know their investments well. This combination is rare, so very few investors are actually engaged in value investing.