What is Value Investing? (Value Investing Tutorial)
Intro:
Value investing is an under appreciated form of investing, so much so that, in some places, people call it “dead”. This is far from the truth, and in reality, value investing provides great returns for patient investors. Read on to find out just what it is, how to find value in a company, and how to differentiate value plays from value traps.
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What exactly is “value investing”?
Value investing is simply the buying of companies (or securities) that are priced below their fair value and the selling of those companies when they become priced above their fair value. A very simple concept to understand, and an effective one, considering it’s rewarded legendary investors such as Benjamin Graham and warren buffet the gift of financial freedom (warren buffet is currently the fourth richest person in the world, and was the richest at one point. I also recommend “the intelligent investor” by Benjamin Graham to anyone who wants to learn how to fully master value investing). The only difficult thing is the execution of this strategy, which a surprisingly large amount of people get wrong.
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How do you value a company?
You can value a company in many ways, but the two simplest metrics I found that immediately tell you whether or not a stock is under or overvalued are the PE and PB ratio. The PE ratio is the one I expect most people to know about, and it measures the price of a companies stock relative to its EPS (earnings per share). A rule of thumb is any PE rating below 15 indicates a buying opportunity for the value investor (when paired with other metrics), and any PE rating above 25 indicates a selling opportunity (when paired with other metrics). However, other strategies have different rules (growth stocks nearly always have a high PE ratio since you are paying a premium for their higher rates of growth), but for value investing that is the rule. Moving onto the PB ratio, or the price to book ratio, it measures the stock price relative to the book value of the company per share. The rule for this metric is any rating below 1 is a indicative of undervaluation, and any rating above one is indicative of overvaluation (which deep value investors avoid buying into at all costs).
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What differentiates a value play from a value trap?
Value plays are true value stocks that have good balance sheets (little debt in proportion to equity, more assets than liabilities, and positive net income) and are relatively large companies (10 billion dollars and up is best, but if you find an opportunity at 2 billion, then go for it. Nothing below that, though). Value traps are fake value stocks that have some of the same attributes as a value play (like low PE and PB ratio’s) but are down for a larger reason other than being unpopular (like looming bankruptcy, negative net income, and unlawful business practices). These can be avoided, however, by doing thorough research into a company, and it’s something every long term investor should do anyways.
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Final thoughts:
Value investing is a potentially lucrative trading strategy, but it does have one major downside. Any stock a value investor buys could take years to become overvalued, and so it isn’t for people who will need the money in the foreseeable future. For those, I present growth investing, which I will do an educational post on soon. It makes as much sense as value investing (in that trading strategy you invest in companies which have had growth for the past 5-10 years) and returns take a shorter time to materialize, although it can still take awhile. Anyways, I hope you enjoyed this insight into value investing, and will do more research into the strategy. Good luck and great trading!
Value investing is an under appreciated form of investing, so much so that, in some places, people call it “dead”. This is far from the truth, and in reality, value investing provides great returns for patient investors. Read on to find out just what it is, how to find value in a company, and how to differentiate value plays from value traps.
——————————————————————————————————————————————————————————————
What exactly is “value investing”?
Value investing is simply the buying of companies (or securities) that are priced below their fair value and the selling of those companies when they become priced above their fair value. A very simple concept to understand, and an effective one, considering it’s rewarded legendary investors such as Benjamin Graham and warren buffet the gift of financial freedom (warren buffet is currently the fourth richest person in the world, and was the richest at one point. I also recommend “the intelligent investor” by Benjamin Graham to anyone who wants to learn how to fully master value investing). The only difficult thing is the execution of this strategy, which a surprisingly large amount of people get wrong.
——————————————————————————————————————————————————————————————
How do you value a company?
You can value a company in many ways, but the two simplest metrics I found that immediately tell you whether or not a stock is under or overvalued are the PE and PB ratio. The PE ratio is the one I expect most people to know about, and it measures the price of a companies stock relative to its EPS (earnings per share). A rule of thumb is any PE rating below 15 indicates a buying opportunity for the value investor (when paired with other metrics), and any PE rating above 25 indicates a selling opportunity (when paired with other metrics). However, other strategies have different rules (growth stocks nearly always have a high PE ratio since you are paying a premium for their higher rates of growth), but for value investing that is the rule. Moving onto the PB ratio, or the price to book ratio, it measures the stock price relative to the book value of the company per share. The rule for this metric is any rating below 1 is a indicative of undervaluation, and any rating above one is indicative of overvaluation (which deep value investors avoid buying into at all costs).
——————————————————————————————————————————————————————————————
What differentiates a value play from a value trap?
Value plays are true value stocks that have good balance sheets (little debt in proportion to equity, more assets than liabilities, and positive net income) and are relatively large companies (10 billion dollars and up is best, but if you find an opportunity at 2 billion, then go for it. Nothing below that, though). Value traps are fake value stocks that have some of the same attributes as a value play (like low PE and PB ratio’s) but are down for a larger reason other than being unpopular (like looming bankruptcy, negative net income, and unlawful business practices). These can be avoided, however, by doing thorough research into a company, and it’s something every long term investor should do anyways.
—————————————————————————————————————————————————————————————
Final thoughts:
Value investing is a potentially lucrative trading strategy, but it does have one major downside. Any stock a value investor buys could take years to become overvalued, and so it isn’t for people who will need the money in the foreseeable future. For those, I present growth investing, which I will do an educational post on soon. It makes as much sense as value investing (in that trading strategy you invest in companies which have had growth for the past 5-10 years) and returns take a shorter time to materialize, although it can still take awhile. Anyways, I hope you enjoyed this insight into value investing, and will do more research into the strategy. Good luck and great trading!
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