Value investing is a simple form of investing, as to do that it doesn’t require having deep insight in finance, it doesn’t require having access to professional analyses or good handling with different types of charts. There are five basics concepts to cover in order to start value investing.
First thing to know is that companies have intrinsic value. That means that you actually know that companies have a certain value. But regardless, not everything is for sale all the time, and when something isn’t listed, it costs more to convince the owners to sell it.
For example, an item on sale sells cheaper than its standard value is, but it is still the same item regardless of it not being sold for its full price. The same thing is with stocks, they have a certain value regardless of their price. The price can be higher or lower, but it is the same stock. Not only has the real value of the stock dictated its price. Buying stocks in order to sell them for higher price makes sense only if you buy them for lower price. So knowing something’s real value is helpful when you want to buy it or sell it.
Second thing to know is that you should have a margin of safety. A nice way of having a margin of safety is to limit your purchase price. Don’t go buying stocks on high prices, because you can’t be sure if their price would later grow, or decline. But when you buy something for a low price, even if it doesn’t repay back – you didn’t lose much money, and there is a chance that you can at least sell it for the same money.
As an example, let’s take a used car that you hope to repair and sell for more. It can happen that there is a huge breakdown that can’t be repaired. In that case you can sell it as scrap, and still save some of loss, rather than if you bought the same car for greater price, hoping that you won’t have to invest a lot in its repair.
In short words, make sure that if you lose, don’t lose much.
If a stock’s intrinsic value is $50, buy it only when the price for it is lower than that, for example when it is $40. Then wait for the price reach its value and you get $10 per stock. There is a chance that the value will grow.
Benjamin Graham, the founder of value investing only bought stocks when they were at 60% of their original value. That’s what margin safety is.
Third important thing to know about value investing is that prices are not everything you need to know about the stock of a company. Value investing implies that stock can be underpriced or overpriced. For example, recession, investors start selling because they start panicking, so the prices go low. On the other hand, something might not be tested yet, but have a great price due to high expectation of its performance that turns wrong. That’s called not believing in efficient-market hypothesis.
Another thing to know is that value investors don’t follow majority. When you see everybody buying – start selling or wait. The reason for that is that when everybody’s buying, the stocks are usually overpriced.
Value investors buy only stocks for what they are – a parts of ownership of a company. Therefore, value investors always aim to buy stocks of companies that have firm foundations and secured future, regardless of what others are doing. That’s called – not following the herd.
Most important thing that is shared with most of investors that work with most types of investing is patience. Every market and trading strategy favors patience. But when value investing is in question, this patience means real patience, diligence and taking your time. Value investing is a true long-term strategy. But anyway, you can’t buy a stock for $40 on Monday and sell it for $50 on Wednesday anyway. Value investing requires months of waiting, or years preferably. A good thing with this is that usually countries charge long term capital profits less than short-term profits (an example would be gambling and lottery in most of the world’s countries).
Anyway, there isn’t a formula for choosing the perfect stock to buy – if there was such a thing, it wouldn’t exist. So patience is, as earlier here said, a value that is required to possess in order to be a successful investor regardless of your strategy. But if you manage to comprehend the first four important things to know about value investing, or if your nature tells you to do things that (you discover) value investors do – you will surely be the one who has lots of patience when investing and waiting your return.
Sometimes, your money prepared for buying a stock just wants to pop out. So you go to the market and look around, find a beautiful company that matches your preferences, but it turns out to be overpriced. Well, don’t buy; wait for it to go cheaper, and in the meantime you buy something else that has a good price. Value investing is about that; rather don’t buy anything than jumping into a purchase that you will regret because you don’t have a strategy prepared for it.