Value investing is based on the premise that the price of a stock may not always truly represent the value of the company. So as an investor, you look for the companies which are trading below their intrinsic value, which means you are buying at a discount. If you hold those stocks in the long term, the market price and value should realign implying that you will reap the rewarding as an investor.
There are many reasons why a stock price may be undervalued.
The ‘Keeping-up-with-the-Jones’ mentality is far-reaching and affects investors and speculators alike. People tend to buy when others are buying and sell when the market is nose-diving. This oftentimes results in the price of a share falling below its value; driven by the excessive supply of shares when people panic-sell.
- Market Corrections
Sometimes after a period of price escalation, the market will dip as the higher prices attract a sell-off amongst investors. This will cause prices to drop below the true value of the firm.
- Analyst Predictions
Analysts tend to have a major impact on the behavior of investors. When a renowned analyst makes a bleak prediction about a company, it is bound to become a self-fulfilling prophecy. In some cases, the predictions may not be very accurate, which gives scope for value investors to grab cheap stocks.
- Seasonal Companies
Companies that are involved in seasonal business tend to have lower prices during off-peak seasons. This is when value investing looks beyond the current price to buy stocks based on their fundamentally determined prices.
- Small Cap Companies
These are the smaller stocks on the exchange which have limited analyst or media coverage. Some of them may present real value for investors as they often trade well below their intrinsic value.
- News Flow
Bad news ‘upsets’ the market leading to sell-offs which affect prices sometimes disproportionately. Warren Buffet is probably one of the biggest advocates for value investing and judging from his track record, we can conclude that it is a strategy that pays off. Here are some value investing principles to follow;
- Buy and Hold
Value investing works best with a long-term view. Temporary market crashes will come and go, but generally, the price of a good stock will maintain upward momentum.
- Zig when they zag
Simply put, value investing involves going against the tide. Buy when others are selling. Focus mainly on the value of the company and not the immediate share price reactions.
- Act like a Robot
Keep emotions out of investing completely. All your decisions should be based on value metrics and fundamental analysis.
- Do not trade stocks, Buy companies
Ignore the markets including their trends and predictions. When value investing, you need to look beyond trading multiples. Focus instead on buying into businesses with strong fundamentals, good management teams and solid profitability expectations.
- Buy only what you can explain
Pick companies whose business model you clearly understand and can explain to someone else. If you do not know exactly what the business does, stay away from it. Value investing is a lot like picking a long-term partner, you must get to know them before you take the plunge.
In conclusion, value investing works best with a long-term mindset. In the short term, your portfolio may fluctuate but the long run will result in an overall price gain. Investment legends like Warren Buffet and Peter Lynch have made millions using this strategy. If you follow these precepts, you stand to gain future value on the stock market.
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