Value investing is more a habit than a process of investment.
Value investing focuses on market price of a stock which is lower than the “value of the underlying business”. Few stalwarts of Value investing like Warren Buffett, Benjamin Graham, John Burr and Philip Fisher, who has made the concept of value investment popular, believes that it is very important to know the “value of business” before buying any stocks. If the value of a business is more (by a multiplying factor) than its current market price of its stock then it automatically becomes a good buy. We will discuss three principals of value investing:
(1) Maintain a Margin of Safety.
Value investors makes sure before buying any stocks that its current market price is substantially below its ‘value’. As a thumb rule, the market price of a stock should be 2/3 of its calculated book value. But it must be told here that book value is not the actual value of a business, it does not take care of other non-tangible values.
(2) Estimating Intrinsic Value.
Intrinsic value principal is based on one theory which says “a dollar in hand today is worth more than a dollar paid in future”. This happens not only because of inflation of money but also because if one has dollars in hand today then he can invest it in deposits and earn extra interest on his investment. So, according to intrinsic value principal investors estimate a companies intrinsic value (say 10 years from now) based on its current market price.
(3) Evaluate Long term prospects
Value investors think almost opposite of traders. Traders are more focused on short term prospects of a particular stocks. Their results are based on historical behaviour of stock prices (called technical analysis). But Value investors always focuses on long-term prospects of stocks. They buy stocks with no immediate objective of selling. Long term stocks are characterized by business showing customer focus, brand name, huge market capture and above all high quality managers managing the business. Value investors buys stocks with objective of holding it forever.
Warren Buffett is live example among league of excellent value investors who follows the above value investing principals to buy business and stocks.