What Is Value Investing
Value investing is the purchase of shares (stocks) at a price lower than their real value. The philosophy of this strategy has two concepts — market price and cost. The price is what you pay, the cost is what you buy. According to this investment strategy, the stock market is not efficient, so there may be undervalued and overvalued assets on the market. An undervalued stock means its market price is lower than its true value. The value investor is trying to find such undervalued stocks, as it believes that in the future the market will overestimate them and the market price will be equal to the true one. The essence of the value investment is well conveyed by the phrase “buy 1 dollar for 60 cents”.
So, value investing is a special type of investment, which is associated not only with the purchase of stocks of companies but with the purchase of precisely those stocks whose sale price is lower than their real value. And this means that after a while, the purchased shares will go up in price and it will be possible to earn a decent amount of money by selling them.
Examples of value investing
In the case of value investing, the investor holds an asset that grows in value over time, even if the investor does not invest any amount of time or energy. For example, a property that you rent to tenants is an asset that generates income and increases the value of an asset through cash flow and a possible increase in the market price of real estate. An asset is what makes you profit, while you remain its owner. The opposite of an asset is a liability. Liabilities take money from you while you own it, for example, a car. Although it provides convenience, if it is not used for business and does not bring added value, it is a liability.
Rich people own assets and continue to accumulate them. The asset may be real estate, stocks, bonds, and so on.
What should professional investors know?
True professionals of the business, experienced brokers who have been trading on the market for more than one year can be engaged in value investing. After all, in order to recognize the real collapse of stock prices of a certain company, which is associated with its financial difficulties and falling stock prices, which is associated with the undervalued potential of the company, you need to have a financial sense and be aware of all the latest market trends.
However, it is not enough to have intuition; you still need to be a good economist and financier. There is no single approach for this calculation, and each investor uses his own method.
Many players in the market do not even notice the difference between the price of stocks and their value, which is why there are cases of undervalued and overvalued securities.
Search criteria for value stocks
In order to find the market the stocks for value investing, you need to know at least the basics that will help to understand the performance of enterprises. So you need to understand that value stocks exist on any exchange, in any industry, and in any country, you just have to look and analyze them thoroughly, using the following criteria:
- The company must be profitable for at least 5 years, and its average profit growth must be equal to not less than 7% per annum;
- The assets of the enterprise should be sufficient;
- The price per stock of the company should not exceed 67% of its real value;
- The company must have the lowest ratio of the price of stocks to profitability among all enterprises in the industry;
- The debt load ratio should be no more than 0.5; otherwise, the company may go bankrupt.
Thus, only by conducting a detailed analysis of enterprises and their financial indicators, you can identify good stocks. The error in the calculations is still allowed, so whatever the real value of the stocks, it should be reduced by 5-10% to create a margin of safety in case of unforeseen circumstances. To make money in this way you need to be an excellent analyst and financier, and know the laws of the market.
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