What Is Value Investing?
This week we want to talk about Value Investing. Value Investing is an investment style, and something different from investing with your values, which we discussed last week.
How are they different?
Value Investing = investing in a stock that is traded at a price that is less than its intrinsic value
Investing with your values = investing in companies that fulfill your internal values criteria, such as companies that respect the environment or that respect gender equality, or are anti-racist
Ok, can you tell me more about value Investing?
Value investing was introduced as a concept in the 30s, by Benjamin Graham. [1] It has been made famous in particular by Warren Buffett, a very famous name in the investment community. As an investor, he has adhered to the principles of value investing throughout his career and made his fortune with it reaching a net worth of $73 billions in the last decade. [2]
It is considered to be an investment style, and it is often discussed in the investing community. Other investment styles are, for example, active and passive investing, growth investing or top-down/bottom-up investing.
Value Investing is a long term investment strategy, as it takes into account ownership of stocks for a long period of time.
But how does it work?
“Long ago, Ben Graham taught me that price is what you pay; value is what you get. Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
– Warren Buffett, from his 2008 Berkshire Hathaway Chairman’s Letter
Value investing relies on the price of a company stock being undervalued, meaning costing less than what the underlying assets are actually worth. But how does this happen?
To understand this we need to take a step back and understand that stocks in the financial markets are theoretically priced at their value (indeed, if you wanted to buy an item worth €10 you would never pay €20 for it, and nobody would be willing to sell it to you for €1). In practice, however, stock prices respond to external factors and news. Investors often overreact, and their overreactions end up causing a price fluctuation in one direction or the other, as a result of the sales or purchases of shares induced by the external factors/news. When a stock price fluctuates it can end up being either overpriced (costing more than what is worth) or undervalued. This is commonly referred to as market volatility [3].
When it is undervalued, it is the moment for value investors to buy the stock, as there is a safety margin. The safety margin is the difference between the trading price and true value. The larger the safety margin, the safer the investment. [4]
So when to invest?
An investment strategy purely based on value investing requires time. And with time we mean years, not weeks.
To start off, it is important to fully understand a business in order to understand whether it is undervalued or not.
By knowing the business it is then possible to calculate and understand what is the true value, but it is vital to wait until there is a safety margin.
Once an undervalued stock is bought, it takes time for the market to adjust and for the price to go up to the real value.
While value investing is an investment style and strategy that has favoured many investors, it is important to understand if it is the right one for you.
If you want to learn more about it, and investing in general, here are some useful resources:
Graham’s The Intelligent Investor from the father of Value Investing
Hagstrom’s The Warren Buffett Way: Investment Strategies of the World's Greatest Investor on how Warren Buffett invests
Buffett's Letters to shareholders where Buffett himself shares his thoughts and considerations
Kiyosaki’s Rich Dad, Poor Dad on what people should know about investing
Shiller’s Irrational Exuberance on while prices fluctuate and market volatility