While the success of famous value investors such as Warren Buffet, Benjamin Graham, or Charlie Munger speaks clearly in support of value investing, it is legitimate to ask how did value investing brings these investors stable and considerate profit through the years. To do this, we must examine in greater detail what value investing is, and why the fundamental theories behind it survived the test of time.
Value investing is an investing strategy first popularised and in large discovered by the famous investor and mentor of Warren Buffet, Benjamin Graham. In his book “The Intelligent Investor”, now considered by many value investors to be the fundamental text of value investing, Graham says: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.” In this statement, Graham’s use of “thorough analysis” hints at what value investing really incorporates.
In its simplest form, value investing is an investment strategy used where an investor looks for a stock that is selling for less than its “intrinsic value” in other words, a share that is in a way discounted. By buying this discounted share the investor knows that when, in the future, the share reaches its real value, the investor will make money on the revaluation. In principle, the ability to compare the price a share is selling at to the price the share is really worth, the investor can make money in the long run.
To set up a comparison with a more tangible example, say you are looking to buy a car that is currently selling for 10 000 euros. Firstly, look at the car, its features, at the company that produced the car, think of how much it will be used, and determine the real value of the car. If the real, or intrinsic, value is 6 000 euros, the car is considered a bad investment as it’s overvalued. Instead of buying you will wait and see if at any point the price of the car drops to a lower value. Due to the drop in demand, the car now sells for only 4 000 euros. You might identify this as a buying opportunity and buy the car, understanding that the intrinsic value of this car is 6 000. Over time, the value of the car rises back to its pre-downturn value, and you made money.
Whilst stocks are not equivalent to cars, value investing can be summed up in a simplification of “buying shares when they are cheaper than they should be”. How much cheaper the share has to be for an investor to buy it depends on the investor, more specifically on what is known as his “margin of safety.” The above-mentioned Benjamin Graham claims he would not buy a stock unless it is selling at 2/3 of its intrinsic (true) value or cheaper.
While value investing seems like a simple task, the true talent comes in understanding when a company is really undervalued. Value investing is not all about buying, which only comes at the very end. The bulk of the process comes in studying balance sheets, cash flow, and the managers of a company that one believes to be a good investment. Buying undervalued stock often means buying the stock that no one else is buying. Big-name companies are usually popular amongst people buying stocks and hence are all too often overvalued, selling for a lot more then they are actually worth. A good value investor must think about the future. Warren Buffet, the current crowned king of investors claims that the best amount of time to hold a stock is forever. A good company to buy is one that has the potential to grow conservatively, reaching its intrinsic value, and growing further, outperforming the market forever. Ideally, this company will also pay out dividends to its shareholders, sending a certain amount of money to people who own its shares, as a small “thank you”.
So why is value investing the best way to invest? In essence, it is simple, because it works. It is not easy, it doesn’t promise “quick money,” it means reading through endless excel tables, studying a company for months, only to decide not to buy it and to keep looking. Value investing is a slow and meticulous study, but the results speak loudly. Looking at the numbers and the people who stuck with this strategy, in my eyes it is clear that value investing is by far the dominant investment strategy if you are willing to wait and put in a lot of effort. Especially in present days stock market crash and slow down, while many day traders fear the volatility, value investors don’t have to worry. If a stock is good it will last and all that is necessary is to wait out the storm. A market crash brings forth the opportunities to invest in companies that were hurt but have the potential of recovering and producing profit on the long term revaluation. Even in volatile times like this, value investing proves to be a superior investing strategy.