Isn’t every investor a value investor? After all, who wants to buy stocks which have no value? Well, probably no one. However, what we are referring to as value investing, in this case, is a particular approach to selecting stocks. In other words, it’s an investing philosophy. Value investing is about finding stocks that are actually worth more than their current value on the market.
The Value Investor
So what makes a value investor different than any other type of stock investor? A value investor is primarily concerned with the actual business and its fundamentals. Other factors that influence the stock’s price are far less important. Furthermore, a value investor is much more likely to choose a company to invest in and stick with it for the long term.
Earnings growth, cash flow, dividends, book value… these are all far more important to the value investor than market factors. It’s basically about finding stocks which are incorrectly valued on the market. This way, when the mistake is corrected and the price on the market reflects the real value of the stock in question, its price should rise.
Basic Guidelines for Value Investing
So what exactly should you look for in stocks if you want to try value investing? We examined the strategies of various value investors, and we have prepared this list of basic guidelines. You don’t have to follow them all, of course. As with any other strategy, you should find a formula that works best for you. However, using some of these tips will definitely be useful.
1. The stock’s Price Earnings Ratio should be as low as possible (preferably in the bottom 10 percent of its sector)
2. The PEG ratio (Prices Earnings Ratio divided by projected growth in earnings) should be lower than 1.
3. The Debt to Equity Ratio should also be lower than 1.
4. The Price to Book ratio should be lower than 1.
5. The stock should have a strong earnings growth over an extended period of time.
6. The price you pay should never be more than 70% of the stock’s intrinsic value.
As a value investor, you are essentially looking for the intrinsic value of a stock. However, calculating the intrinsic value of something is not very straightforward. Finding the book value is easy (the value of buildings and equipment), but what about intellectual assets?
Value investors look at the value of companies as ongoing businesses. From this point of view, the intangibles, such as the brand, trademarks, patents, and current research and development are very important. These fundamentals drive the future growth of the business in many cases, not hard assets.
How to Calculate Intrinsic Value
Calculating the intrinsic value of a stock is quite a complicated process. You can check out this article for a step-by-step guide on how to calculate the intrinsic value yourself. You can also find various tools on the web that will help you with your calculations.
Morningstar.com, for example, will tell you the “fair value” of a stock. You need to be a member to see the “fair value” of a stock, but you can take a two-week trial to try the service for free.
No matter which strategy you choose for calculating the intrinsic value, it’s always important to give yourself a margin of error. It’s very easy to make a mistake with this kind of calculations, so being prepared for errors can save you from some big losses.
Going for a value-based approach might not give you quick results. Just like investing in general, it takes some practice to succeed. However, many investors have had great success with this kind of approach. Just keep in mind that it’s an approach that takes time. Invest carefully and you will succeed in the long run!