- Posted by: Brighter Mind
- Category: Value Investing
Every investor follows a different investment style while investing into stocks of a company. One among the various well known styles is “Value Investing”.
“Value Investing” is an investment style which was conceptualised by legendary value investor Benjamin Graham and later made famous by his disciple Warren Buffett; another legendary investor & CEO of Berkshire Hathaway. “Value Investing” Investment style primarily focus on buying stock of a company below its intrinsic value and emphasize on “margin of safety”.
So let us understand the cornerstones of the “Value Investing” in details:
1. Intrinsic Value
The intrinsic value of a stock is the actual value based on the fundamentals of the company. The fundamental of the company includes business model, company moat, earnings power of the business, capital allocation policies and corporate governance etc.
In short term, stock prices fluctuate based on demand-supply scenario which gets influenced by various external factors like global macro factors, market conditions, Industry specific news and corporate events. Sometimes, these factors cause a stock to trade below the intrinsic value without significant change in the company’s fundamentals. Value investing focuses on these mis-priced opportunities to generate returns.
2. Margin of Safety
As we have seen in the above section, value investing particularly deal in investing in a stock that is trading below intrinsic value. This difference between the intrinsic value of a stock and its market value is called the margin of safety.
For example, suppose ABC Ltd stock has the intrinsic value of Rs.100 and is currently trading at Rs.50, so we can say that the stock has a 50% margin of safety. So, the higher the margin of safety, the better the possibility of higher returns.
It also helps protect the downside risk as the investment is done at a discounted price. Over a period of time, stock prices attain their intrinsic value hence gaining profits on investment. But before investing, you should first understand the reason behind the stock trading below its intrinsic price.
3. It takes time
The most important aspect of value investing is that it requires time for the investment to fetch returns.
This is because; companies may take months or even years to achieve their intrinsic value. Hence value investors have to keep patience so that they can take maximum advantage of their investments. There are many examples in the equity market where the stock hadn’t moved an inch over years and then became multi-bagger and offering multi-fold returns.
Hence value investing requires time and patient investors get rewarded. The major reason for this is that the equity market is volatile in short term, but in long term, the market is efficient.
4. It’s a Behavioural Game
Today, information is widely available over various sources like news channels, the internet, etc. But the real dilemma is how you filter out pieces of information. There are many traders and investors in the equity market who process this information differently. Some follow the herd mentality, while some opt for a contrarian approach.
In value investing, your behaviour as an investor defines your investment outcome. It requires you to think out of the box and make investing decisions against the odds. This is the reason value investors invest in the stocks which everyone is ignoring and end up generating significant returns.
In the stock market, there is a saying that “Know what you own and why you own it!”
And this holds true in value investing because this saying get tested in the market. How deeply you understand the company and how accurate are your hypothesis while investing define your investment returns.
Remember, in “Value investment”, minimizing the possibility of permanent loss of capital is of top priority and this style, if executed well, can help you achieve higher returns with safety of capital