Value investing
Value investing is an investment approach which uses ‘bottom up’ ‘fundamental analysis’, and which has elements of buy and hold investing. In other words, it is a long term investing approach that focuses on analysing the underlying business.
There are a couple of concepts important to value investing. The first is that value investors believe a company has an intrinsic value, or an underlying worth, which tends not to jump about, but instead grows and shrinks inline with the performance of the underlying business. They use fundamental analysis of a company’s assets, earnings, cash flows, competitive position and management, amongst other things, to determine a stock’s intrinsic value. It’s not necessarily a precise number, but an estimate taking into account all these factors.
Value investors then compare the company’s share price with its intrinsic value per share. The idea is to buy shares in a particular company when they are trading below that value. This gives rise to the second important concept— margin of safety. As intrinsic value is necessarily an estimate you should only buy the shares when there is a significant difference between the price and the value. This margin of safety lowers your chances of getting it wrong.
Finally, value investors prefer solid, well-managed businesses over those with inconsistent histories. The belief is that good businesses will outperform also-rans over the long term. And if that happens, the share price should follow.
Further Reading
- Value investing fundamentals examines the basic principles of value investing, reviews its practitioners and looks at the reasons for its success. It's a great introduction to a very profitable investing approach.
- Leithner one of the best Australian value investing sites, with plenty of well-written, informative articles.
- ‘The superinvestors of Graham and Doddsville’ is a highly recommended extract from a lecture by Warren Buffett.
