What Is Value Investing?
“If you are an investor, your decision to buy and sell is based on the underlying economics of the stock you own.”
Value investing is how Warren Buffet built his fortune. Mr. Buffet learned from his professor at Columbia University, Benjamin Graham, to whom the above quote can be attributed.
Graham is widely considered to be the father of Security Analysis is the seminal work on value investing. In 1949, Graham followed up with The Intelligent Investor, which quickly became a classic on the subject. In the second book his focus shifted from individual companies to groups of stocks and investor behavior.
Rather than chasing popular names or looking for fast-moving stocks, Graham preferred a more quantifiable, disciplined approach to investing. He preferred to invest based on the “underlying economics” of the stock.
The goal of a value investor is to find companies with strong profitability that are currently priced below the true value of the company. Mr. Graham called this “margin of safety.” The bigger the difference between the market and economic value, the greater the margin of safety.
How Does Value Investing Work?
“Spinoza’s concluding remark applies to Wall Street as well as to philosophy: ‘All things excellent are as difficult as they are rare.”
In order to determine a company’s level of profitability and its true value, investors must analyze annual financial reports that are often several hundred pages long. This part alone is no easy task.
After getting a picture of the company’s financial health, a value investor must then decide on their expectations for the company. Everything from revenue, costs, tax rates, and profit must be forecasted to determine the value of the company at present.
This work takes time and ample amounts of research, and can scare off less disciplined investors. Maybe this is why so few investors actually follow the entire process to find truly undervalued companies?
