Value Investing Approach
Value investing involves buying stocks trading below their intrinsic worth and holding long-term for gains as share prices rise toward business value. Value investors prioritize buying at discounts rather than chasing expensive popular stocks. Learning proven value criteria, valuation techniques, and risk management strategies enables successful value stock selection.
What is Value Investing?
Value investing means purchasing stocks appearing undervalued by the market relative to business fundamentals and earnings power. Value investors:
- Seek securities priced cheaply relative to measurable value
- Emphasize minimizing losses and protecting capital over maximizing gains
- Focus on margin of safety buying well below fair value
- Hold for long periods allowing business value to be recognized
Patience and discipline allow value stocks to appreciate as they revert toward and exceed fair valuations over time.
Core Tenets of Value Investing
Foundational principles of effective value investing include:
- Intrinsic Value – Determine fair value based on business’s earnings capacity and assets.
- Margin of Safety – Buy at significant discount to leave room for error.
- Contrarian Approach – Be willing to go against prevailing market sentiments.
- Long Time Horizon – Allow fundamentals, not technicals, to drive returns over long holding periods.
- Limit Risks – Focus on limiting downside before seeking increased returns.
Advantages of Value Investing
Key benefits to value stock investing:
- Doesn’t depend on rising markets, only sound business execution
- Provides cushion through discounted purchase prices
- Leverages pessimism and negative psychology that depress stock prices
- Achieves better risk-adjusted returns compared to growth approaches
- Simpler metrics focus analysis on business quality and cash generation
Value Investing Criteria
Common metrics flagging attractively priced value stocks:
- Low Price/Earnings and Price/Book value ratios
- High Dividend Yield percentages
- Low Price/Cash Flow and Price/Sales ratios
- Trading significantly below historical averages and 52-week price highs
Multiples should reflect lower expected growth, not deteriorating fundamentals. Compare valuations against a company’s own history, competitors, and the overall market.
Value Stock Screening Strategies
Screen for value stocks exhibiting:
- Low P/E and P/B ratios below market, competitors, and historical averages
- Earnings yields far exceeding bond yields
- High return on capital over time signaling a competitive advantage
- Strong balance sheets with manageable debt levels
- Dividend payouts near 50% of earnings
Historical returns validate value screens consistently outperforming expensive growth stocks long-term.
Value Investing Research Process
Thorough research evaluates all aspects of a business:
- Products, services, and competitive landscape
- Competitive advantages from brands, assets, scale, or intellectual property
- Management quality and capital allocation track record
- Revenues, earnings, margins, debt levels over business cycles
- Growth outlook factoring macroeconomic conditions
Take sufficient time understanding businesses versus just viewing as statistical bargains.
Classic Value Investing Strategies
Proven value investing approaches include:
Dividend Payers – Target mature companies sharing profits through dividends signaling earnings strength.
NCAV Stocks – Purchase companies with share prices below Net Current Asset Value to capture liquidation value.
Spin-Offs – Capitalize on discounted spin-off companies as parent firms distribute shares.
Fallen Angels – Identify quality companies facing short-term setbacks distorting value.
Asset Based – Seek overlooked value in hard assets like real estate and mineral rights.
Apply styles fitting your circle of competence tailored to specific stock strengths.
Notable Value Investors
Legendary practitioners following value investing tenets with remarkable long-term track records include:
- Benjamin Graham – Original value investing founder and author of The Intelligent Investor
- Warren Buffett – Greatest modern value practitioner allocating Berkshire Hathaway capital
- John Templeton – Value mutual fund manager who bought at market bottoms
- Seth Klarman – Iconic value hedge fund manager with one of the best records
- Jean-Marie Eveillard – Ran the First Eagle Global Value mutual fund for decades
- Tweedy Browne – Prominent value oriented investment firm managing value-based mutual funds
Study how the masters practice value investing for shared wisdoms.
Value Stocks vs Growth Stocks
Value and growth approaches represent complementary tactics with different priorities:
- Inexpensively priced with pessimism
- Higher yields and stable “bargain” valuations
- Underfollowed and contrarian choices
- Costlier but higher total return potential
- Riskier but with greater profit growth assumptions
- Need economic expansion and bullish conditions
Employ both approaches in moderation based on specific stock traits. Blend together balancing a portfolio.
Quantitative Value Factors
While qualitative judgement plays an important role, proven quantitative value metrics to screen for include:
- Low price-to-earnings (P/E), price-to-book (P/B) and price-to-sales (P/S) ratios
- High dividend yield and high return on invested capital (ROIC)
- Low debt-to-equity (D/E) ratio
- Reasonable price-to-earnings-to-growth (PEG) ratio between 1-2x
Assess ratios relative to historic averages and industry/sector peers rather than absolute figures. Trends over time better indicate value.
Value Investing Risks
While reducing some risks, value investing carries unique challenges like:
- Becoming stuck owning “value traps” appearing cheap statistically but with deteriorating fundamentals making true value elusive
- Missing runaway growth stocks avoided due to high valuations
- Having long periods of underperformance when “expensive” market segments rally strongly
- Needing patience holding out-of-favor stocks until market sentiment shifts back
Manage risks through analyzing beyond just superficial metrics, diversifying across approaches, and allowing long time horizons.
Global Value Investing
Value principles applying in the US translate internationally as well:
- Screen foreign developed and emerging markets for overlooked bargain stocks
- Be aware of unique foreign market structural differences
- Verify geopolitical stability and currency valuation tailwinds
- Ensure access to accurate foreign financial reporting
- Build a portfolio of best values across markets weighted by risk
Adjust for elevated risks and lower transparency, but markets misprice foreign stocks similarly.
The time-tested value investing philosophy offers proven approaches to equity investing success. But long holding periods allow business results and growth to drive returns more than traders’ moods. Have confidence buying out-of-favor bargains that others overlook. Upside takes time to be realized. With patience and discipline, value stocks purchased at discounts deliver favorable risk-adjusted returns over full market cycles.