Value investing is sometimes misunderstood, as many investors end up investing in low-cost investments that are not popular or attractive at the moment.
Indeed, investing in value involves choosing quality assets in a calculated way and having the will to go against the grain. To better understand this investment method, here are some rules to follow if you plan to practice value investing.
Be aware of the intrinsic value of investing
Many investors rely on stock price movements to decide whether to buy or sell their holdings. On the other hand, value investors generally believe that a stock price can be similar to its long-term intrinsic value.
As a result, value investors see an opportunity to buy a discounted stock when it is trading for less than its underlying market value.
The intrinsic value of a stock can be determined in several ways. You can use a simple price-to-book (P/B) ratio to compare the company’s market value to its book value. Typically, a P/B ratio below 1 means the stock is selling below the net asset value (NAV) of the company.
Another simple metric is the price-to-earnings (P/E) ratio, which compares the company’s stock price to its earnings per share (EPS). A low P/E ratio often suggests that the company is undervalued, making it a valuable stock.
If you want to be more specific, you can try financial metrics like price-to-earnings-to-growth (PEG) and enterprise value to earnings before interest, tax, depreciation, and amortization (EV/EBITDA) ratio.
Note that while there are different ways to calculate the intrinsic value of an investment, value investors don’t rely solely on the stock price to decide what to do next. On the contrary, the determination of intrinsic value is a crucial factor for them.
Calculation rather than speculation
Economist and father of value investing Benjamin Graham teaches in his book The Intelligent Investor that value investing is an investment method that requires fundamental analysis and in-depth research.
Furthermore, value investing aims to minimize the risk of permanent capital losses and allows investors to make a decent profit instead of putting money into risky investments that are not certain to provide returns. adequate.
Given these characteristics, you can say that value investing is anything but speculative. Instead, it is calculative, qualitative, and somewhat predictive.
Avoid going with the flow
Value investing focuses on the opposite end of market noise. This is because stock prices typically trade below their underlying value when the majority of investors have their attention elsewhere.
Value investors often take a different path than most investors choose. Although it may seem like a not-so-wise decision, being certain of your choices matters more than being afraid of looking like an irrational investor.
Not every investor can be a contrarian player in the market, although it is essential to be one if you seek to thrive as a value investor.
Have a good understanding of investing
Security selection is an important aspect of value investing that sets it apart from other investment strategies.
To choose potential value investments, you need a fair amount of information about the asset and the company. This includes knowing the type of business the company engages in, its industry, its competitive advantage, etc.
It is also important to keep abreast of any developments that may affect the business. You can do this by reading and analyzing the company’s financial statements and quarterly analyst calls or contacting management.
Additionally, you may consider getting the opinions of other shareholders on issues such as competition, customers, and production to get a better idea of the company’s prospects.