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What is Value Investing?

Value investing is an investment strategy, where investors buy stocks that are not trading at their deservedly fair prices, and wait for the companies to appreciate in the long-term, gaining dividend payments, tax benefits, and any capital gains from the increase in stock price, if an increase took place. 

This is extremely common in the stock markets around the world. 

Whether you consider a standalone stock, a mutual fund, a consolidated list of a certain number of companies and their shares, or an index in its entirety, all share prices are a result of the perceived value. 

The value of a stock undergoes appreciation when the market is bullish, for genuine or unfounded reasons. The value of the same stock can undergo depreciation when the market is bearing, again for genuine or unfounded reasons. This is the natural behavior of the stock markets, and also of all the traders, investors and individuals dealing with the various indices.

Value investing is a practice wherein you pick a particular stock that is not getting its due, buy it and hold on to it till the price undergoes significant appreciation. 

Value investing is NOT about buying  stocks that already have an inflated price and are getting “analyzed” by “the guy who predicted Amazon!”. It is always about finding undervalued stocks, through your own due diligence, and creating long-term passive revenue. 

The sole purpose of value investing is to buy in when the price is low and to make a windfall gain when there is a fair or generous appreciation. Bearish markets are usually ideal for value investing. 

But, even a bullish market can have undervalued stocks. 

Investors, traders, fund and portfolio managers, and individuals, all have their own perception of what a particular stock should be valued at, and this leads to discrepancies in stock prices. 

Algorithms and other tools used for predictive purposes and analyses tend to have their shortcomings as well. The simple recipe for success with value investing is to find that undervalued, underestimated and underperforming stock, usually through fundamental analysis.

Brief history of value investing

The history of value investing dates back almost a hundred years to Benjamin Graham. The economist, investor and professor at Columbia Business School came up with the theory of value investing, along with fellow professor of finance David Dodd. They coauthored Security Analysis, which was published in 1934. According to Graham, it is quintessential to determine the true or actual value of a share, stock or equity, through extensive and methodical research. Graham and Dodd, as well as many others in those years, advocated against ascertaining the value of a stock on the basis of its market price. The focus should instead be on the intrinsic value of a stock. All these experts agreed that if the true value of a stock is determined and it is a meticulously worked out inference, then the market price of the same equity will eventually undergo the requisite appreciation and the two figures will converge. It is also highly likely, as per their theories, that the market price of such a stock, which has been undervalued for a sustained period, can be significantly greater than the intrinsic or true value in due course of time. Value investing goes against the many norms that were prevailing then and are also common today. Most traders tend to estimate the price of a stock, based entirely on obtained information, speculation, herd mentality in the market and other influencing factors. Graham, Dodd and others suggest that investors should not indulge in such estimation. Speculation should be kept at bay and one must not get swayed by the market dynamics. All forces at play in a stock market usually prioritize the minor profits through immediate trading. There is a rush to make a quick profit. Such practices tend to misevaluation of stocks and their true prices.

Successful Value Investors

Benjamin Graham was himself a very successful and wealthy investor. He acquired most of his wealth through investments, and while using his own strategies, such as value investing. 

It is necessary to mention here that the legendary investor Warren Buffett was a student of Benjamin Graham. Buffett actually received an A+ grade from his mentor Graham at Columbia University in 1951. It is no secret that Buffett is one of the most celebrated value investors in the world, perhaps of all time. It is also no secret that Graham was himself a legend, and is widely considered a pioneer.

Buffett has gone on record several times and spoken about the influences of Graham on his early years as a student, then as an investor and subsequently as a billionaire. Graham gave away most of his fortune, so not many people nowadays know what his true net worth was. However, he was among the most successful value investors of the twentieth century.

Warren E. Buffett is inarguably the most successful value investor of the last fifty years. When he became the CEO of Berkshire Hathaway, most of the strategies implemented by Buffett were directly based on the principles of Graham and Dodd, as published in ‘Security Analysis’. Buffett describes Graham’s teachings and especially his advises as “simple”, “powerful” and “timeless”. Buffett has been a value investor ever since his adolescence. He actually went to Columbia because of Graham, who was a professor there at the time.

There have been and are many successful value investors over the decades. The second half of the twentieth century witnessed the rise of value investors such as Mario Gabelli, Charles Royce, Glenn Greenberg, Walter Schloss, John Shapiro, Michael Lee-Chin, David Abrams, Mohnish Pabrai, Allan Mecham and Tom Gayner.

The relevance of value investing

Value investing will always be relevant, as long as the stock markets exist and operate the way they do now. Let us use a simple example to explain the reality. 

Consider a company making a product or offering a service based on artificial intelligence. The product or service may encompass the internet of things, from automation and robotics to self-improving algorithms.

Very few people in the world understand the true potential of artificial intelligence. Those who actually have a substantial understanding are mostly techies. They are tech innovators, some of whom may be entrepreneurs. 

The common trader on the floor of a stock market, an investor who has dealt in traditional industries, an ordinary citizen or anyone else do not know the intrinsic value of the stock of such a company. Hence, the trading price of every share of such a pioneering company is bound to be undervalued. 

This is where value investing becomes imperative.

If you can identify stocks that are undervalued and you can infer through your extensive methodical research that there is a near certainty of the shares attaining their deserved price in the near or distant future, then you should invest and wait for the opportune time. Value investing has made many billionaires over the last eighty years. Anyone can become a value investor. The key is to have the ability to identify undervalued stocks.