Value investing

Quick definition

Value investing is a strategy based around buying securities that appear to be trading at a discount relative to their intrinsic or underlying value.

Key details

• Value investing means buying financial assets that you consider to be undervalued by the market
• Warren Buffet is the most famous value investor
• Value investing tends to perform better as a strategy during market downturns, where the prevailing sentiment about many companies is negative

What is value investing?

Value investing is an investment strategy pioneered by the likes of Benjamin Graham and Warren Buffet, where the goal is to buy assets that are undervalued compared to their fundamental ‘worth’. In many cases, this means buying assets that the market doesn’t like for whatever reason, which could be poor short term earnings, bad PR, or a lack of hype.

Value investing is well suited for long-term investors who are not in a rush to generate returns. In times of market downturns, the value investment strategy tends to perform better than any other strategy as investors get an opportunity to assess securities trading at a discount relative to their potential and long-term prospects.

How important are price and value in value investing?

Price and value are the two most important factors taken into consideration when it comes to value investing. The investment strategy places the most focus on the difference between the two metrics.

While the price is the amount that you pay to own a given stock, value is what you get after paying the price. For this reason, value investors try to estimate the value of a given investment prior to paying the underlying price.

Consequently, a good investment would be one whose value will increase as soon as you pay the actual price. Value estimation is one of the most important aspects when it comes to value investing. According to Benjamin Graham, the father of value investing, a good investment whose value has the potential to increase over time needs the following characteristics:

• Current assets are twice current liabilities
• Long-term liabilities don’t exceed net current assets
• Stable profit for several years
• Price to Earnings ratio does not exceed 15
• Price to book ratio is no more than 1.5

What is the safety margin in value investing?

Maintaining a higher safety margin is also an important aspect when it comes to value investing. Safety margin is the difference between the market price that you pay for an investment and the intrinsic value. According to Benjamin Graham, the lower the market price of a stock relative to its true value, the greater the safety margin, and the higher the probability of the investment generating significant returns in the long run.

The safety margin should always be higher as it reduces the potential impact of negative factors and errors that might take a toll on investment value. With a sufficient security margin, it is less likely that adverse events along the way would affect the long-term results of an investment.