A beginner in investments spends an extraordinary amount of time figuring out the various strategies, stock types and jargons that are part and parcel of the stock arena. We’ve been told time again that making money out of stocks requires an understanding about the stock market, some patience and effort; and a lot of planning. Yet many an avid investor has made a mark by simply following the techniques of the top investors.
Benjamin Graham and Warren Buffet are two such examples of master investors who have amassed an incredible amount of wealth through stock success. It is through their words of wisdom that many investors have been encouraged to pave their own path in this money-making market.
While the original theory of value investing and identifying value stocks has evolved since its inception by Graham, it’s certainly a tried and tested method worth looking further into.
Value stocks are those which are found at discount rates in the stock market despite the indications of a higher intrinsic worth by fundamental analysis.
What this means is that the basics of the company point towards the likelihood of acceleration in the business’ worth.
The concept of value stocks is based on a number of factors:
Intrinsic worthThe intrinsic worth of a company is its true value. While the price of a stock is constantly changing, it is the fundamental factors of a company that determine what it is actually worth.
The up-kept qualitative factors of a company along with its financial records are generally a testament to its past glory and also speak of the strides it is likely to make in future.
The key then to profiting through value stocks is to find shares that are being sold at prices far lower than their intrinsic worth.Margin of safety
While clearly buying at a discount price benefits the investor, there is no point in investing in stocks which will add no gains to your portfolio. This self-preservation technique says that it’s best to buy when the price of stock reaches a value, equivalent to the intrinsic value of the stock, discounted for all risk factors that may affect the same. The advantage of this safety limit is to ensure a profit while downsizing the risk.
Inefficient market hypothesisThe efficient market hypothesis states that the fundamentals of a company are reflected in the price of its stock. Value investors shun this theory and instead choose to believe that it is investor perceptions that lead to the over or under pricing of a stock in the stock market.
Therefore, as investors’ moods are in constant imbalance, the price of a stock will take its time to self-correct, invariably attaining its intrinsic potential.
Contrarian approachThe value investor believes that it is the herd mentality of people that contributes to stock price changes.
Since it is the real worth of a company that holds the most weight for a value investor, this particular strategy discounts the patterns of the crowd.
When the average investor is in a buying overdrive, the value investor is intent on selling his shares. On the other hand, when the rest are out selling their stock, this strategic investor buys in bulk.
This approach of opposite action works on the belief that the fundamentals of a company are still intact. When the investor frenzy settles, the company will eventually prove its worth by rolling in profits.
With these core factors in mind, the value investor turns to selecting the value stocks. There are a certain characteristics worth looking at while estimating the intrinsic worth of a company:
The value investor looks for companies which have a lower P/E ratio as this may be an indication of an undervalued stock.
Earnings yield tells you the percentage of earnings you’d make on a share in comparison to the price at which you bought it.
When the earnings yield is higher, it is a sign of a value stock, as it indicates that a stock can bring in far greater earnings than what its current price reflects.
The book value is the total worth of a company’s tangible assets after it has deducted any debts it owes. When the price of a share is less than the book value it means that the stock is undervalued, and a potential value stock.
Though these calculations provide valuable insight into whether the worth of the stock is likely to climb, there are some precautions the investor must take:
Financial records are necessary in identifying value stocks. Having some knowledge of the basic calculations helps, but even more important is to ensure you’ve made no errors.
The issue with financial equations is that investors may take different factors into account while doing their calculations.
Another aspect to consider is that companies vary in their methods. Therefore, to correctly compare many companies it would require an understanding of what each included in their earnings profile.
A fundamentally stable company is one that will steadily profit over time. Yet every once in a while there comes a period when a business incurs an abnormal amount of gain or loss. These isolated occurrences usually take place due to an expected business event or macroeconomic factors.
To correctly assess how a business usually performs you must cut these irregularities out of the equation.
The goal of every value investor is to ensure you get the best bargain possible. That way if the stock goes south you’d limit your risk.
It’s best to buy at a risk-discounted estimate from the share’s real worth. This ensures a reasonable margin of safety for the value investor.
We all know the benefits of a diversified portfolio. The ‘don’t keep your eggs in one basket’ theory aids the investor by spreading the risk.
Value investors also employ this strategy, but prefer to stick to a limited selection. The trick is to find stocks which belong to a range of sectors.
A key component of value investing is to take a contrarian approach. Therefore, it is important to not to give in to your emotions and instead take action when a loss that’s bound to continue has been determined.
The best time for a value investor to sell is when stocks are overvalued in comparison to their intrinsic worth.
Despite the risks one must consider, the value concept has benefited the investor in a clear cut way. While the margin of safety sets a boundary for losses, the long-term holding allows for higher returns.
With a simple understanding about the stock market, a bit of patience and some fundamental research, you can join the ranks and reap the rewards of being a value investor too!
MoneyWorks4Me rating and ranking of funds for SIP is available to subscribers only. Moneyworks4Me is not a rating and ranking agency, however it is required that users have a way of selecting funds and building a Portfolio. The method used by it are described below to enable users to understand the logic behind the rating and ranking Subscriber will find more details on this in the various content made available from time to time. In case you need more please write to besafe@moneyworks4Me.com
MoneyWorks4Me rates and ranks mutual funds based on the following data-driven system:
Funds ranking in screeners: Performance Consistency and Quality are two parameters used for ranking funds for SIP. The ranking as follows GG, GO, GR, OG, OO, OR, RG, RO and RR.
With the same color-coded funds, the one with the higher Average 3-year rolling returns (over 5 to 10 years), the number that appears in the Performance tag, ranks higher.
Here is the summary:
The third tag Upside Potential is not relevant for SIP. It is relevant for lumpsum investments in Mutual Funds.
Make an informed decision for Stocks
Invest using an intelligent system with powerful data-driven tools that help you identify opportunities and make informed buy-hold-sell decisions
Buy quality Stocks when they are available at reasonable prices and supported by an upward price trend and Sell when they are Overvalued using the Decizen Rating System. Covers 3500+ stocks
Download APP
