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What is Value Investing (And Why Should You Care)?

If you invest, knowing value investing can help give your portfolio more stability and consistency. Here's what it is and how to get started.
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Gen Z, you’re looking for a long-term solution for your investments. You want to find a way to make your money work for you to have a solid financial future. And value investing may be just what you’re looking for.

Value investing is a type of investing that focuses on finding stocks that are undervalued by the market. This means that the stock is worth more than what it’s currently selling for on the open market. When you invest in these stocks, you stand to gain a lot of value over time as the stock price rises.

However, value investing isn’t without risk. You’ll need to do your research and be patient, picking the right stocks and waiting for them to increase in value. But if you can master this type of investing, you’ll be well on your way to building a solid financial future.

What Is Value Investing and How Does It Work?

So what is value investing? Value investing is an investment strategy that involves buying stocks that are undervalued by the market and holding onto them until they reach their full potential.

The goal of value investing is to find companies that are trading at a discount to their intrinsic value, or the true worth, of the company.

With value investing, investors believe that the market eventually corrects itself, and that by holding onto these undervalued stocks, they will eventually be rewarded with a higher price.

Many famous value investors, such as Warren Buffett, have made billions of dollars following a value investing strategy. While it can take patience to wait for these stocks to rebound, value investing strategies are a proven way to generate long-term wealth.

How Did the Value Investing Strategy Start?

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Value investing all started with Graham and Dodd. In the early 1930s, two Columbia Business School professors. 

Benjamin Graham and David L. Dodd wrote a book called Security Analysis. This book, which is still used today as a textbook in many finance classes, laid out the principles of value investing.

Basically, Graham and Dodd argued that the market was often irrational and that there were opportunities to buy stocks at a discount to their intrinsic value.

They advocated a methodology for finding these “value stocks” and outlined several value investing strategies for managing risk.

Over the years, many successful value investors have followed the principles outlined in Security Analysis, including Warren Buffett, Charlie Munger, and Walter Schloss.

While there have been some changes to the original framework over the years, value investing remains one of the most popular approaches to buy stocks today.

Understanding Value Investing

When I talk about value investing, I’m referring to a strategy that involves finding “value” stocks that are trading for less than their intrinsic value.

In other words, you’re looking for quality stocks that are undervalued by the market. There are many different ways to measure a company’s intrinsic value, but one of the most common methods is to use a company’s financial statements (I’ll talk more about this below).

You can also look at things like the company’s future cash flows, the company’s assets, and the company’s prospects for growth

Once you’ve identified a company’s stock you believe is undervalued, you can then start buying these undervalued stocks and holding onto them until the broader market itself and the stock’s market value reaches what you believe to be its true value.

Value investing is a great way to grow your portfolio over the long term, but it’s important to remember that it can take a while for value stocks to reach their intrinsic value.

When following value investment strategies, patience is key, which leads to my next point.

Value Investing Requires Diligence and Patience

As a value investor, I’ve learned that two essential qualities are required for success: diligence and patience.

The allure of value investing (and frankly, being considered an “intelligent investor”) is that it offers the potential for outsized returns.

But unlike other investing strategies, such as growth or momentum, value investing requires a patient and disciplined approach.

That’s because value investors are often contrarian in their thinking, which means they’re willing to buy when everyone else is selling and vice versa (more on contrarian thinking later).

Moreover, value investors typically don’t invest in the hottest stocks or the latest fad; instead, they’re looking for quality companies that are undervalued by the market and have the potential to generate strong returns over the long haul.

This requires a deep dive into a company’s future cash flows (as well as the company’s stock price), as well as an understanding of its competitive position and future prospects. In other words, it’s not for the faint of heart.

But for those who are willing to put in the work, value investing can be a highly rewarding pursuit. Indeed, some of the most successful investors in history, such as Warren Buffett and Benjamin Graham, have made their fortunes by following a value-centric approach.

So if you’re thinking about trying your hand at value investing, just remember: it takes diligence and patience to be successful.

What Makes a Good Undervalued Stock?

At its core, there are a few key factors that value investors look for.

1. Good Value Stocks Are Undervalued by the Market

One of the most important things to look for when trying to find a good value stock is whether or not the market has correctly valued the company. Oftentimes, the market will overvalue certain companies while undervaluing others. As an investor, you want to try to find those companies that are undervalued by the market.

2. Good Value Stocks Are Ones With a Low Price-to-Earnings Ratio

Another thing to look for when trying to find a good value stock is a low price-to-earnings ratio. The price-to-earnings ratio is simply the stock price divided by the earnings per share. A low price-to-earnings ratio indicates that the stock is undervalued and may be a good value investment.

3. Good Value Stocks Are Ones With a High Dividend Yield

Another thing to look for when trying to find a good value stock is a high dividend yield. The dividend yield is simply the annual dividend divided by the current stock price. A high dividend yield indicates that the stock is undervalued and may be a good value investment.

4. Good Value Stocks Are Ones Trading at a Discount to Their Intrinsic Value

The final thing to look for when trying to find a good value stock is whether or not it is trading at a discount to its intrinsic value. A stock’s intrinsic value is the company’s true underlying value and can be estimated using various methods. If a stock trades at a discount to its intrinsic value, it may be a good value investment.

You can also use this advanced screener to help you find stocks that fit certain value investing criteria.

How to Identify a Value Stock

To find a value stock, you need to come up with an intrinsic value for that company. Without getting too complicated, here are a few tips to find an undervalued company:

1. Know the Company’s Financials Inside and Out

This is probably the most important tip on the list for finding a value stock. You need to know a company’s financial situation better than anyone else to identify whether or not it is trading below its intrinsic value.

Review the balance sheet, income statement, and cash flow statement carefully. Understand the company’s business model and how it makes money. Research the industry and understand the competitive landscape. 

Only then will you be able to accurately assess a company’s true value. You can actually do most of your research on the best investment apps in the market right now.

2. Be Patient and Wait for the Right Opportunity

Investing is a long game, and you’re not going to find a value stock trading below its intrinsic value if you’re not willing to wait for the right opportunity.

It might take months or even years to find a stock that meets all your criteria, but it will be worth it when you finally find that needle in the haystack.

3. Look for Companies With High Levels of Insider Ownership

Insider ownership is a good indicator of management’s confidence in the company’s future prospects. If management owns a significant amount of that company’s stock, they are much more likely to make decisions that are in the best interests of shareholders rather than their own personal interests.

4. Avoid Companies With High Levels of Debt

High levels of debt can put a lot of pressure on a company’s stock, making it more difficult for them to meet their financial obligations and potentially putting them at risk of bankruptcy.

Therefore, you should generally avoid companies with high levels of debt when looking for stocks that are trading below their intrinsic value.

5. Look for Companies With Strong Competitive Advantages

Competitive advantages can come in many forms, but they all give a company an edge over its competitors and help to ensure its long-term success. And this isn’t just looking at stock prices either.

Sure, stock prices are important, but some examples of competitive advantages include brand recognition, patents, proprietary technology, and economies of scale.

Companies with strong competitive advantages are more likely to be undervalued by the market because investors may not fully appreciate their long-term potential.

6. Use Valuation Models to Estimate Intrinsic Value

There are many different ways to estimate the intrinsic value of a stock, but no matter which method you use, remember that it is only an estimate.

The key to finding intrinsic value is to use multiple valuation methods and compare the results to get a range of possible values for the stock. Then you can use your own judgment to determine whether or not the stock is trading at a discount to its intrinsic value.

Value investing takes patience and careful research (especially when deciphering an intrinsic value), but the rewards can be great if you choose the right stocks.

By seeking out undervalued companies and holding onto them for the long term, you can build a strong and successful portfolio.

Why Do Stocks Become Undervalued?

Two young engineers Testing and verifying the operation of the machines forming metal sheet tiles in the factory

There are a lot of reasons that a company may become undervalued. But first, it’s really important to remember that for someone who thinks a company is undervalued, there is always someone who thinks that the company is overvalued, which is sort of why this whole thing works.

That said, here are some of the reasons I’ve found companies to be “undervalued”:

1. The Company Is in Debt

One of the primary reasons why a stock may become undervalued is if the company is in debt. If a company has a lot of debt, it may be difficult for it to make interest payments, which can lead to financial problems and ultimately cause the stock price to decline.

2. The Company Is Losing Money

Another reason why a stock may become undervalued is if the company is losing money. If a company is not generating enough revenue to cover its expenses, it will likely have to borrow money or sell assets, which can lead to a decline in the stock price.

3. The Company Is Being Investigated

If the company is being investigated by regulators or law enforcement, this can also lead to a decline in the stock price. This is because investors may be concerned about the outcome of the investigation and whether or not the company will be able to continue operating as usual.

4. The Company Has Poor Management

If the company has poorly performing management, this can also lead to a decline in the stock price. This is because investors may lose confidence in the ability of management to run the company effectively and generate profits.

5. The Market Is Bearish

If the overall market conditions are bearish, this can also lead to individual stocks becoming undervalued. This is because investors may be selling off stocks in general due to concerns about the economy or other factors

Value Investing Principles

Now that you understand the basics of what value investing is, let’s take a look at some principles to guide your approach:

Contrarian Perspective

There’s a reason the Buffett Doctrine is to “be fearful when others are greedy and greedy when others are fearful.” When everyone else is fully invested in the market, prices are at their highest, and it’s time to start selling. Similarly, when the market has crashed, and everyone is selling, that’s often when the best opportunities to buy into amazing companies at a discount present themselves.

In other words, it can pay to have a contrarian perspective when value investing. Of course, it’s not always easy to go against the crowd. After all, if everyone else is selling, it can be tough to convince yourself to buy. But if you’re patient and do your homework, you can often find some of the best investment opportunities when everyone else is running for the exits.

Evaluation of Intrinsic Value

When it comes to investing in stocks, there are a lot of different opinions out there about what is considered “intrinsic value.” To complicate things further, “intrinsic value” can mean different things to different people.

However, one of the most commonly accepted definitions is the one put forth by Benjamin Graham in his book “The Intelligent Investor.” According to Graham, intrinsic value is the true worth of a company, as opposed to its market value (which can fluctuate quite a bit).

So how do you go about determining a company’s intrinsic value? Unfortunately, there is no surefire formula for figuring out intrinsic values.

Instead, it requires a lot of research and analysis. You need to look at various factors, including the company’s financial stability, competitive landscape, and growth potential. It can be a lot of work, and even then, there is no guarantee that you will arrive at an accurate number. In other words, intrinsic value is often more of an educated guess than anything else.

That being said, following the principles laid out by Benjamin Graham can help you get closer to an accurate estimate of intrinsic values.

And while there is always some element of risk involved in stock investing, knowing the true intrinsic value of a company can give you a big advantage.

Seeking Margin of Safety

When you’re investing in stocks, it’s always important to remember that the market is unpredictable. Even the best-informed investors can’t always predict when a stock will go up or down.

Value investors seek to minimize this risk by looking for stocks that are undervalued by the market. In other words, they look for stocks that are selling for less than they are actually worth.

But even with an undervalued stock, there’s always the risk that the stock will continue to decline in value. That’s why value investors also look for a margin of safety.

This is the difference between the stock’s current price and its estimated intrinsic value. If there’s a large margin of safety, it means there’s less risk that the stock will decline further in value.

So, when you’re value investing, always remember to seek out a margin of safety. It could be the difference between a profitable investment and a losing one.

Perspectives for the Future

The future is an unknowable place. That’s why, as a value investor, I don’t try to predict it. Instead, I focus on the present and making the best investment decisions I can with the information I have today.

Of course, that doesn’t mean I don’t think about the future at all. Part of value investing is clearly understanding what you hope to achieve with your investments. Do you want to retire early? Build a nest egg for your children’s education? Or simply make enough money to live comfortably in retirement?

Once you know your goals, you can start to think about how a value-investing approach might help you achieve them.

For example, if you’re saving for retirement, you’ll likely want to focus on investments that offer stability and income, such as bonds and dividend-paying stocks. On the other hand, if you’re trying to build wealth for the future, you might be more willing to take on some additional risk in pursuit of higher returns.

No matter what your goals are, though, remember that the future is always uncertain. Value investing is about finding businesses that are trading at a discount to their intrinsic value today and holding them for the long term. As long as you do that, you’ll be in a good position to weather whatever storms come your way in the years ahead.

Value Investing Strategy

Okay – I’ve preached. Now let’s talk about how to implement a sound value investing strategy.

Don’t Fall Prey to Fear

Fear is a powerful emotion. And when it comes to investing in stocks – especially value stocks where you’re trying to determine a company’s intrinsic value – it can be easy to let fear guide your decision-making.

However, there are a few things you can do to avoid falling prey to fear:

  • First, take a long-term view. When you’re looking at stocks through a value investing lens, it’s important to remember that you’re investing in a company, not a short-term bet. This means that you shouldn’t be afraid to hold on to a stock even if it’s underperforming in the short term. Over time, the stock is likely to rebound, and you’ll be glad you held on.
  • Second, don’t put all your eggs in one basket. Diversifying your portfolio is crucial to mitigating risk when taking a value-investing approach. Investing in various stocks – both value and growth – you’ll be less likely to see your portfolio suffer if one particular stock takes a dip.
  • Finally, remember that there’s always risk involved in investing. No matter how much research you do or how confident you are in your picks, there’s always the chance that something will go wrong. The key to value investing is to accept this risk and continue investing anyway. After all, the only way to make money in the stock market is to take some risks. So don’t let fear stop you from potentially profiting from your investments.

Wait For The Right Time To Buy

You’ve been following a company for years. You’ve watched it grow, you’ve studied its financials, and you’ve even talked to the CEO.

You think you know everything there is to know about it.

So when it announces a new product that could potentially be a game-changer, you’re convinced that now is the time to buy. But good value investors know that they need to be patient and wait for the right time to buy.

Even if it means missing out on what seems like an amazing opportunity.

It can be difficult to watch from the sidelines as other investors make a killing on a stock that you think should be yours. But if you want to be successful as a value investor, you must have the discipline to wait for the right price.

With value investing, the goal is to buy low and sell high, sometimes waiting for the perfect opportunity. Even if it takes months – or even years – to find it.

Do Your Research

When I first started investing in stocks, I had no idea what I was doing. I would read articles online and listen to people talk about stocks, but I didn’t really understand the jargon.

It wasn’t until I took a course on investing (and talking to more value investors) that I learned about the two main types of stock analysis: fundamental and technical.

Fundamental analysis looks at a company’s financials to determine whether it is a good investment. This includes things like its earnings, revenue, debts, and assets.

On the other hand, technical analysis focuses on chart patterns to predict future price movements.

Once I understood these two concepts, I could start doing my own research and making better investment decisions. However, I also learned that good research takes time.

Value investors will tell you there is no shortcut to success in investing; you have to be willing to do the work. But if you’re patient and do your homework, you can find some great opportunities in the stock market.

Focus on Long-Term

Value investing is all about finding bargains in the stock market. That means looking for stocks that are underpriced by the market and waiting patiently for them to rebound. It’s a simple concept, but it can be difficult to stick to in practice.

After all, when you see a stock that has dropped in value, it can be tempting to sell it immediately to avoid further losses. However, value investors always remember that the goal is to find stocks that are trading below their intrinsic value while maintaining a clear margin of safety (more on this below).

Value investors selling too soon can mean missing out on substantial profits down the road. That’s why successful value investors always focus on the long-term and resist the urge to panic when the market drops.

There are no shortcuts in value investing, but sticking to a disciplined approach can reap substantial rewards over time.

Avoiding Value Traps

A “value trap” is a stock that appears to be undervalued by the market, but actually has little or no upside potential. The main reason why value traps exist is that when the market is efficient,  prices eventually reflect all available information about a company.

However, there are a few ways to avoid value traps:

  1. First, take a close look at the financials. If a company loses money, it’s probably not as cheap as it seems.
  2. Second, beware of companies with high levels of debt. This can often signal that the company is in trouble and the share price may not recover.
  3. Finally, don’t fall for “mass delusion.” Just because everybody else is buying a stock doesn’t mean you should too.

With a little due diligence, you can avoid falling into a value trap.

Risks Associated With Value Investing

Although value investing strategies have low-to-medium risks, there is always a chance the investment will fail and lead to losses. Below are some risk factors that increase the chances of failure:

1. Value Investing Can Be a High-Risk Strategy

Value investing is a high-risk investment strategy that involves buying stocks that are currently undervalued by the market and holding onto them until they reach their full potential. While this strategy can lead to high returns, it also carries great risk. If the stock market were to crash, value investors could see their portfolio values plummet.

2. You Could Lose All of Your Money

Building off the prior point, one of the biggest risks associated with value investing is the possibility of losing all of your money. This is because value stocks are often much more volatile than the overall market. While the market may only lose 10% in a crash, value stocks could easily lose 50% or more. As such, a patient value investor must be prepared to weather some significant losses if they want to succeed with this strategy.

3. Your Investments May Not Perform as Expected

Another risk associated with value investing is that your investments may not perform as expected. This can happen for several reasons, including changes in the overall market or the specific industry that you’re invested in. If your investments don’t perform as planned, you could lose money.

4. You May Not Have the Stomach for It

Value investing can be a very emotionally demanding investment strategy. This is because you will often buy stocks that are deeply undervalued and, therefore, unpopular with other investors. This can lead to a lot of second-guessing and self-doubt, which can be difficult to handle if you’re not prepared for it mentally.

5. You Need to Be Patient

Value investing is not a get-rich-quick scheme; it’s a long-term strategy that requires patience and discipline. This is because it can take years for a stock to reach its full potential price. If you’re not prepared to wait it out, value investing may not be your right strategy.

Growth vs. Value Investing

When it comes to investing, there are two basic approaches: growth investing and value investing. Growth investors focus on companies that are expected to experience above-average growth, while value investors seek out companies that they believe are undervalued by the market. Each approach has its own advantages and disadvantages.

Value investing is often considered the more conservative approach, as it focuses on buying stocks that are trading at a discount. This can provide a cushion against downward price movements, making it a good choice for risk-averse investors. However, value stocks can often be out of favor with the market for extended periods, making them difficult to sell.

Growth investing, on the other hand, can offer the potential for higher returns, but it also comes with greater risks. The market often lauds growth stocks, and their stock prices can be very volatile. For this reason, growth investors must be prepared for both ups and downs.

Ultimately, there is no right or wrong approach to investing; it all depends on your individual goals and risk tolerance.

Growth investing may be right for you if you’re willing to stomach some volatility in pursuit of higher returns. But if you prefer a more stable investment with modest returns, value investing may be a better fit.

Is Value Investing Right for You?

I’ve beaten this into the ground at this point. Value investing isn’t for everyone – it takes a lot of patience and discipline to stick with this type of investing strategy over the long term.

If you’re not prepared to wait years for your stocks to reach their full potential, then value investing may not be right for you.

Additionally, if you’re not comfortable with the idea of taking on more risk to potentially earn higher returns, then growth investing may be a better fit.

Alternatives to Value Investing

If value investing isn’t your jam, here are a few other methods you can try:

1. Growth Investing

Growth investing is an investment strategy that focuses on companies that are experiencing rapid growth. Growth investors typically seek out companies with strong fundamentals, such as high sales growth, high-profit margins, and low debt levels. While growth stocks can be more volatile than other types of stocks, they can also provide investors with the potential for higher returns.

2. Momentum Investing

Momentum investing is an investment strategy that focuses on companies that are experiencing strong momentum. Momentum investors typically seek out companies with strong fundamentals and positive earnings surprises. While momentum stocks can be more volatile than other types of stocks, they can also provide investors with the potential for higher returns.

3. Index Investing

Index investing is an investment strategy that seeks to track the performance of a specific market index, such as the S&P 500. Index funds are mutual funds that allow investors to invest in a basket of stocks representing the index. Index investing offers many benefits, including diversification, lower costs, and simplicity.

What is Couch Potato Value Investing?

In the investing world, there are all sorts of strategies and approaches to try to generate returns. Some people focus on finding the next big growth stock, while others focus on companies with a long track record of dividend payments.

And then there are those who take a more passive approach, looking for companies that are currently out of favor but have sound fundamentals. This latter approach is called “couch potato” value investing.

The basic idea behind couch potato value investing is to find companies that the market has discounted for one reason or another, but which still have a strong business model and promising future prospects.

This could be a company that is in a cyclical industry and is currently out of favor due to lowered earnings or a company that has been hit by some negative news but still has a solid balance sheet.

By buying these kinds of companies when they are out of favor, investors can hope to generate above-average returns when the market eventually turns in their favor again.

Of course, couch potato value investing is not without its risks. The biggest risk is that the market may never turn in favor of the company you’ve invested in, and you could end up stuck with a losing investment.

But for those who are willing to do the research and are patient enough to wait for the market to turn, couch potato value investing can be a great way to generate above-average returns.

Frequently Asked Questions (FAQs) About Value Investing

What is meant by value investment?

Value investing is an approach to investing that focuses on finding stocks that are trading at a discount to their intrinsic value. The goal of value investing is to buy these stocks and hold them for the long term, waiting for the market to recognize their true value. This can be a great way to build your portfolio and generate higher returns over time.

Is value investing a good idea?

Value investing is a good idea for investors who are willing to do their research and are patient enough to wait for the market to turn. By buying stocks that are trading at a discount to their intrinsic value, investors can hope to generate above-average returns when the market eventually turns in their favor. However, this approach is not without its risks, and investors should know the potential for losses.

What is value investing by Warren Buffett?

Warren Buffett is one of the most successful value investors of all time. He is known for his focus on fundamentals and his long-term investment horizon. Buffett is also a big proponent of index investing, and he has said that “the best way to be a successful investor is to buy Index Funds.”

Is Warren Buffett a value investor?

Yes, Warren Buffett is a value investor. He made his fortune by finding stocks that were undervalued by the market and investing in them. This type of investing can be a great way to build your portfolio, but you’ll need to do your research and be patient.

About the author

Chris Muller

Chris has an MBA with a focus in advanced investments and has been writing about all things personal finance since 2015. He’s also built and run a digital marketing agency, focusing on content marketing, copywriting, and SEO, since 2016.