What is Value Investing, how it Works & Strategies

We have all heard stories about underdogs who go on to become massively successful. In the investment market, everyone wants to invest in stocks that are under the limelight for all the right reasons. No one wishes to invest in a stock that hasn’t been performing well. Of course, who would like to set themselves up for a loss? However, value investing works differently. Keep reading to find out all about this investment tool that stock market moguls like Warren Buffet swear by.

Value Investing Definition

Value investing is all about looking at the intrinsic value of stocks. It is an investment strategy using which investors put their funds into a stock that has been underappreciated by the market. They do this in the belief that these stocks will perform well in the future.

Value investors actively seek out stocks that they think are being undervalued by the market. Using this buy and hold strategy, they are able to purchase a stock for cheap and reap significant returns when its intrinsic or book value shines through. However, it is not so simple. How do you figure out which stocks are underperforming? Moreover, out of the underappreciated stocks, which one seems to have a promising future? Read further to understand the basics.

Additional Read: Investment Strategies for The Lump sum/ One Time – High-Value Investor

Guide to value investing

Before you embark on the journey of value investing, you must know some basic principles that will help you succeed.

How Does Value Investing Work?

Value investing focuses on identifying stocks that are undervalued compared to their intrinsic worth. Investors typically evaluate a company’s financial performance, market position, and future growth prospects to determine its true value. The idea of value investing is to buy these stocks at a discount and hold them until the market recognises their worth, helping you generate significant gains.

For example, suppose company A is trading at Rs. 500 per share. However, based on its financials its intrinsic value is estimated to be Rs. 700 per share. This means it is underpriced due to market sentiment or other factors. You can leverage this opportunity to buy the shares of company A at Rs. 500. Over time if the stock value rises to Rs. 750, you will gain Rs. 250 per share.

Evaluate the intrinsic value

The ‘intrinsic value’ is the most important term you will encounter while value investing. This is the real or intrinsic value of the stock, which has plummeted due to global trends or market changes. When this happens to a trustworthy, reputed company, you can invest in their stocks at a low price.

Do your research

Before investing, you need to research thoroughly on several factors. Make sure that the company you’re investing in is reliable and has a good track record. Take your time to understand the company’s future business plans, financial structure and short-term profits. Don’t disregard a company simply owing to unpopularity. Value investing is all about finding hidden gems.

Value Investing Strategies

- Insider buying and selling: Monitoring insider activity, such as purchases or sales of company shares by executives, can help you understand their sentiment about the company's future. Significant insider buying often signals undervaluation.

- Analyse financial reports: Reviewing the income statements, balance sheets, and cash flow reports can help you identify companies with solid fundamentals. Look for low debt levels, consistent profitability, and an attractive price-to-earnings (P/E) ratio.

- Portfolio diversification: Spreading investments across industries and market sectors is a key strategy to reduce risk. A diversified portfolio can help you mitigate the impact of a poorly performing stock on the entire portfolio.

Keep a margin of safety

This is the most important principle of value investing. When buying a low-valued stock, buy it at least two-thirds of its original or intrinsic value. Since the stock is already underperforming, the chances of it doing worse after you buy it are low. So, whatever growth it experiences will be your guaranteed profit. Suppose you buy a stock whose intrinsic value is Rs. 100 at Rs. 60. When it reaches its intrinsic value, you will make a Rs. 40 profit, and if it surpasses this value, you will make greater profits.

Additional Read:  Safe investments to ride out market volatility

FAQs on Value Investing

1. What is meant by value investing?

Value investing is an investment strategy where investors seek undervalued stocks based on their intrinsic worth. The goal is to invest in companies with solid fundamentals and growth potential, trading below their fair market value.

2. What is an example of value investment?

An example of value investment is buying a company’s stock when it is undervalued. For instance, purchasing Coca-Cola shares during a market downturn when its fundamentals remain strong.

3. What is value investing Warren Buffett?

Warren Buffett's approach to value investing involves purchasing stocks of companies with consistent earnings, competitive advantages, and strong management.

4. What are the benefits of value investing?

Value investing minimizes risk by focusing on undervalued stocks with growth potential. It provides opportunities for higher long-term returns, helps avoid market speculation, and fosters a long-term approach.