Choosing A Stock: Value Investing (Part 3 of 5)

Welcome to Part 3 of the “Choosing A Stock” mini-series. If you missed Part 1, Part 2, or both, I encourage you to go back, check them out.

In Part 3, we will be examining another strategy that prospective investors often use as a method of picking the stocks that they feel will best benefit their portfolios. To reiterate Parts 1 & 2, there are many different strategies that investors use to make the most informed decisions possible, but there is no one strategy that is fool proof. This week, we will focus on one of the most widely practiced strategies: value investing.

Although there is not a single moment in time when value investing was created, many people consider Benjamin Graham and David Dodd, both finance professors at Columbia University in the 1930s, to be the men who laid the foundation. Fortunately, the idea of value investing is rather straight-forward and has remained the same since its conception: find companies that are trading for a price that is below their inherent worth. In other words, “buy a dollar for fifty-cents.”

The stock market as a whole is very big and, contrary to popular belief, even with modern market analysis technologies, valuation mistakes can and do happen all the time. For instance, companies can become incorrectly valued (or undervalued) by the market, which means there is potential that the share price will increase when the market corrects the valuation error. A value investor essentially seeks out these types of situations and attempts to capitalize on them. More specifically, a value investor searches for companies trading at bargain prices that can still be deemed “high quality” because they have traits like strong fundamentals (including earnings), cash flow, dividends, and book value. An extremely important thing to remember is that value investors are searching for value buys and not just cheap buys. Not all stocks that are experiencing a decline in price and seem to be trading for a cheap price are of high value. In fact, it could be argued that most are not. As result, successful value investors must become great at doing research so that they can be confident in making informed decisions that help them pick high quality, yet undervalued stocks.

Even some of the greatest investors of all time use value investing. For instance, look at Warren Buffet. Just in case you are unfamiliar, Warren Buffet is the founder of Berkshire Hathaway, a holding company, which he brought from $12 a share in 1967 to $70,900 in 2002. Moreover, Berkshire Hathaway has outperformed the S&P 500 by roughly 13.02% on average annually. A truly incredible accomplishment. Even though Buffet does not consider himself to be strictly a value investor, there is no denying he uses value investing principals when considering an investment. In fact, early on in his career he was even quoted as saying, “I’m 85% Benjamin Graham,” when being asked about his strategy for approaching investments.

Without a doubt, value investing can be complicated in practice, but luckily, it is relatively simple in theory. If you can buy stocks that are trading below their intrinsic value, you should be able to profit off them when the market corrects itself. Just remember, value investing often takes a lot of focused research so the best course of action is to practice as much as possible. Think of this as just another tool to put under your investing tool belt. Thank you for reading Part 3 of the “Choosing A Stock” mini-series, and please stay tuned for Part 4!