Best Investment Strategy For Long Term Growth – Value investing is an investment strategy that involves selecting stocks that are trading below their intrinsic or book value. Value investors actively sell stocks that they believe are undervalued by the stock market. They believe that the market overreacts to both good and bad news, leading to stock price changes that are inconsistent with the company’s long-term fundamentals. An overreaction provides an opportunity to profit by buying stocks at bargain prices.
Warren Buffett is probably the most famous value investor today, but there are many others, including Benjamin Graham (Buffett’s professor and mentor), David Dodd, Charlie Munger (Buffett’s business partner), Christopher Brown (another student of Graham’s), and billionaire Hedge- Foundation. Manager Seth Klarman.
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The basic concept of everyday value investing is simple: knowing the true value of something can save you a lot of money when you buy it. Most people agree that whether you buy a new TV on sale or full price, you’re getting the same TV with the same screen size and picture quality.
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Stock prices work in a similar way, meaning that a company’s stock price can change even if the company’s price remains the same. This means, strictly speaking, that there is no true or intrinsic value to a company’s stock. But there are relative values.
Market participants can buy or sell stocks without being tied to an objective price index. Hence, stocks, like televisions, go up and down in demand, causing price fluctuations. If the company’s fundamentals are the same and its future prospects are the same, then the share price will be essentially the same regardless of the price difference.
Value investing was developed from a concept by Columbia Business School professors Benjamin Graham and David Dodd in 1934 and popularized in Graham’s 1949 book, The Intelligent Investor.
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Because TVs are sold several times a year, value investors argue that the stock’s performance is the same because buyers who realize it doesn’t make sense to pay full price for a TV. Of course, unlike TVs, deals don’t go on sale at predictable times of the year like Black Friday, and their sale prices aren’t advertised.
Value investing is the process of doing detective work to find hidden bargains in stocks and buy them at a discount to market valuation. Investors may be well rewarded for buying and holding these value stocks for the long term.
A cheap or discounted stock equivalent is when its shares are undervalued. Value investors hope to benefit from deeply discounted stocks.
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Investors use various metrics to determine a stock’s price or intrinsic value. Intrinsic value is the sum total of the application of financial analysis, such as the study of a company’s financial performance, revenues, profits, cash flows, earnings, and fundamentals. It includes the company’s brand, business model, target market and competitive advantage. Some of the metrics used to evaluate a company’s stock include:
Free cash flow is the cash left over after expenses are paid, including operating expenses and large purchases called capital expenditures, such as purchasing equipment or upgrading a manufacturing plant. If a company generates free cash flow, it has money left over to invest in the future of the business, pay off debt, pay dividends or bonuses to shareholders, and buy back stock.
Of course, many other metrics are used in the analysis, including analysis of debt, equity, sales and revenue growth. After looking at these indicators, a value investor can decide to buy a stock if the relative value—the current share price in relation to the company’s intrinsic value—is attractive enough.
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Value investors require some margin of error in their value estimates, and they often set their own “margin of safety” based on their risk tolerance. One of the keys to successful investing, the margin of safety, is based on the premise that buying stocks at a low price allows you to make a profit by selling them later. A margin of safety reduces the likelihood of losing your money if a stock does not perform as you expect.
So if you buy a stock at $66, assuming it’s worth $100, you’ll make a profit of $34 waiting for the stock to rise to $100. Moreover, the company grows and becomes more valuable, which allows you to earn even more. If the stock price rises to $110, you will have made $44 since you bought the stock in the sale. If you bought $100 at full price, you would only make $10.
Benjamin Graham, the father of value investing, only bought stocks at two-thirds of their intrinsic value or less. This was a margin of safety that he believed was necessary to minimize the negative impact of the investment and to obtain the best return.
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Value investors do not believe in the efficient market hypothesis, which states that stock prices take into account all information about a company, so their prices always reflect their value. Instead, value investors believe that stocks can be overvalued or undervalued for a variety of reasons.
For example, stock prices may be low because the economy is doing poorly and investors are panicking and selling (as in the Great Recession). Alternatively, stocks may be overvalued because investors are too excited about an unproven new technology (such as the dot-com bubble). Psychological biases can cause stock prices to rise or fall due to news such as disappointing or unexpected earnings announcements, product recalls or lawsuits. Stocks can also be undervalued because they trade under the radar, meaning analysts and the media don’t cover them enough.
Value investors have many of the opposite characteristics – they don’t follow the herd. Not only do they reject the efficient market hypothesis, but they often sell or pull back when everyone else is selling. They sell or hold when everyone else is selling. Value investors don’t buy trendy stocks (because they’re usually expensive). Instead, they invest in companies that are not well-known if they are considered financially. They also take a second look at stocks that are household names when their stock prices fall, believing that such companies can recover from failure if their fundamentals are strong and their products and services are still quality.
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Value investors only care about the intrinsic value of stocks. They think of buying shares for what they really are: an ownership interest in a company. They want to have companies with sound principles and sound finances, regardless of what others say or do.
Estimating the true intrinsic value of a stock involves some financial analysis, but it also involves subjectivity, meaning it’s sometimes more of an art than a science. Two different investors will analyze the exact same valuation data for the same company and make different decisions. So you need to develop a strategy that works for you.
Some investors who only look at current financial data do not have much confidence in estimating future growth. Other value investors focus primarily on a company’s future growth potential and expected cash flows. Some do both: Famed investment guru Warren Buffett and Peter Lynch, who ran Fidelity Investment’s Magellan Fund for several years, both look at valuation multiples to analyze financial statements and identify when the market is misvaluing stocks.
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Despite the different approaches, the basic logic of value investing is to buy assets below their current value, hold them for the long term, and profit when they are at or above their intrinsic value. It does not provide instant gratification. You cannot expect to buy a stock on Tuesday for $50 and sell it for $100 on Thursday. On the contrary, you may have to wait several years for your stock investments to pay off and sometimes lose money. The good news is that for most investors, long-term capital gains are taxed lower than short-term investment gains.
As with all investment strategies, you need to be patient and work hard to stick to your investment philosophy. You may want to buy a stock because the fundamentals are good, but if the price goes up, you should wait. You want to buy the most attractively priced stock at the time, and if none of the stocks meet your criteria, then you have to sit and wait and let your cash sit idle until an opportunity presents itself.
If you don’t believe in the efficient market hypothesis, you can identify reasons why stocks are trading below price. Here are some factors that can lower a stock’s price and cause it to depreciate.
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Sometimes people invest irrationally based on psychological biases rather than market fundamentals. They buy when the price of a particular stock is rising or when the overall market is rising. They see that if they had invested 12 weeks ago, they could have made 15% by now, and they are afraid.
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