There are a number of different approaches to investing. Different theories of what is likely to work best abound. For more “ordinary” people, though, investing strategies that focus on looking for the best values, or using dividend stocks, or focusing on index funds or ETFs that are more focused on moving with the market, without trying to time stocks and beat the market.
One of the strategies that can help you get best value for your investing dollar is to engage in value investing. Value investing takes a look at the sort of “value” a stock has in an effort to find stocks that are undervalued and investing in those for future profits. It’s not exactly the same as investing in a growth stock, but the hope is that there will be growth, due to true value, down the road.
Basics of Value Investing
As the name implies, value investing is about finding value. While you want to choose stocks that have good value, value investing isn’t exactly the same as timing the market. It’s more about looking for good deals. The assumption made by most value investors is that the market overreacts — whether it’s good news or bad news. As a result, the price movements of a stock may not actually correspond to its true value. Instead of looking only at the price of a stock, a value investor looks at the company’s long-term fundamentals and decides whether or not that stock is overvalued or undervalued.
In order to figure out the value of a stock, many value investors look to the price-to-book ratio and the price-to-earnings ratio. Both of these ratios offer insights into whether or not a stock price is low or high as related to its intrinsic value. Understanding intrinsic value is one of the difficulties that many run into when they first start with value investing. Realize, too, that value investing methodologies differ as well. There are several different approaches to value investing, some focused more on future possibilities, and some focused more on emphasizing the current situation, when making evaluations of a stock’s fundamental value.
This is the value that the stock has in terms of fundamentals. Intrinsic value takes into account the possible future cash flows, risks, growth, and other factors associated with the stock. As you might imagine, intrinsic value is hard to pinpoint. This is because different investors value things differently. While intrinsic value is based on facts about the company, and hard numbers, the interpretation of these numbers — and what it means for the value of an investment — is largely subjective.
As a result, the goal in value investing is often to buy an investment at a large enough discount that errors in judgment can be corrected for. With the right margin safety, it’s often possible for a savvy value investor to overcome some of the mistakes made in choosing a value stock.
More on Investing
In any case, it’s important to realize that intrinsic value is more about looking at the fundamental, or “big picture”, aspects of an investment. You can apply some of these concepts to various types of investing, whether it’s dividend investing, or valuation-informed indexing, or some other approach. Decide what you think equates value in an investment, and then look for opportunities that match your ideas of what makes stocks a good deal.
Before you develop any investing strategy, you need to ask yourself what you want to accomplish, and how you are best likely to accomplish it. Value investing, at its core, is about finding something that costs less than it’s really worth. It requires a certain degree of research and study, since you will need to figure out whether the intrinsic value of the investment is discounted sufficiently from its current market value to provide you with the chance of substantial gains down the road. But, for those who take the time to develop a solid approach, value investing can work as a long-term investing strategy.