Value Investing

What Is Value Investing?

Value investing is an investment strategy in which the investor seeks to profit by buying stocks they believe are underpriced or undervalued by the market at large. The investor looks to buy stocks when they believe they are "on sale," just as they would buy a box of cereal at the supermarket when it's on sale rather than paying full price.

The idea of value investing was popularised and explained by Benjamin Graham in his 1949 book, The Intelligent Investor: The Definitive Book on Value Investing. Graham's most famous student and disciple is Warren Buffett, chairman of Berkshire Hathaway and considered one of the greatest investors of all time.^[1]

Advantages Of Value Investing

By buying stocks they believe are underpriced, the value investor hopes to profit when the general market eventually comes to the same conclusion and boosts the price of the stock to its rightful value.

For example, the stock is trading at US$60 a share, but the investor believes—through their research of the stock and the underlying company—that its true worth is $100. They also believe that the market will eventually come around to their way of thinking and the price will rise to US$100, at which point they will earn a US$40 profit.

Buying stocks at a bargain price also provides the investor with a cushion, or margin of safety, in the event the stock price goes down or stays flat in the interim. For example, if an investor paid US$100 for a stock that then fell to US$80, they would be sitting on a US$20 loss. However, if they bought it at US$90, thinking its true worth is US$100, they would only be out US$10. Conversely, if it was bought at US$60, the profit would be US$20.

Value stocks often pay high dividends, which gives investors an even bigger cushion against loss. If they reinvest the dividends, they can accumulate more shares at lower prices, a tactic called dollar-cost averaging.

As a result, value investing is usually appropriate for more defensive, risk-averse investors with a long-term investment horizon who are just as, if not more, concerned about losing money than they are about how much they can make.

Disadvantages Of Value Investing

Value investing involves patience, something many investors don't possess. It sometimes takes years before the market fully appreciates the true value of a stock, during which time the investor's money could have been put to more profitable uses. As a result, investors looking to make a quick buck should probably avoid value investing, or only allocate a small portion of their portfolio to it.

However, if the investor is prepared to wait, they would be compensated somewhat through dividend payments. Sometimes, however, the investment never pays off, or not as much as the investor hoped it would.

By the same token, it can often be hard for investors not to second guess themselves and to stick to their guns and "go against the herd" while waiting for the market to fully value the stock.

Value investing also often takes a lot of time to do the proper research required to discover hidden, undervalued assets.

Summary

Value investing is an investment strategy that seeks to find bargains in the stock market, that is stocks believed to be undervalued at current prices by the market at large. Value investing involves buying stocks generally out of favour with most investors. As a result, value investing involves patience and often a great deal of research to spot underpriced shares.