Value investing is
sometimes misunderstood that several investors end up putting money into
low-priced investments that are not popular or attractive at the moment.
In fact, value
investing involves choosing quality assets in a calculated manner and having
the determination to go against the flow. To better understand this investment
method, here are a few rules to follow if you plan to practice value investing.
Be Aware of the
Investment’s Intrinsic ValueMany investors rely on stock price movements to decide whether they
should buy or sell their holdings. On the other hand, value investors usually
believe a stock price can be similar to its intrinsic value in the long run.
As a result, value
investors see an opportunity to purchase a stock at a discount when it is
trading for less than its underlying value in the market.
A stock’s intrinsic
value can be determined in several ways. You can use a simple price-to-book
(P/B) ratio to compare the company’s market value to its book value. Typically,
a P/B ratio under 1 means the stock is selling below the firm’s net asset value
(NAV).
Another simple metric
is the price-to-earnings (P/E) ratio, which compares the company’s share price
to its earnings per share (EPS). A low P/E ratio often suggests that the firm
is undervalued, making it a value stock.
If you’re looking to be
more specific, you can try financial metrics such as the price/earnings to
growth (PEG) ratio and the enterprise value to earnings before interest, taxes,
depreciation, and amortization (EV/EBITDA) ratio.
Note that while there
are various ways to calculate an investment’s intrinsic value, value investors
don’t rely on the stock’s market price alone to decide what they will do next.
Rather, determining the intrinsic value is a crucial factor for them.
Calculation Over
Speculation
Economist and father of
value investing Benjamin Graham teach in his book The Intelligent Investor that
value investing is an investment method that requires fundamental analysis and
in-depth research.
In addition, value investing
aims to minimize the risk of permanent capital losses and allow investors to
turn a decent profit instead of putting money into risky investments that are
not certain to provide adequate returns.
Considering those
features, you can say that value investing is anything but speculative.
Instead, it is calculative, qualitative, and somewhat predictive.
Avoid Going with the
Flow
Value investing focuses
on the opposite end of the market noise. That is because stock prices usually
trade below their underlying value when the majority of investors have their
attention elsewhere.
Value investors often
take the route different from the one chosen by most investors. While that may
seem like a not so wise decision, being certain of your choices matters more
than being afraid of looking like an irrational investor.
Not every investor can
be a contrarian player in the market, although it is essential to be one if
you’re looking to thrive as a value investor.
Have a Good Grasp of
the Investment
Stock selection is a big part of
value investing that separates it from other investment strategies.
In choosing potential
value investments, you need a good amount of information about the asset and
the company. That includes knowing the type of business the company engages in,
its industry, competitive advantage, etc.
It’s also important to
keep up with any developments that may affect the firm. You can do that by
reading and analyzing the company’s financial statements and quarterly
analysts‘ calls or getting in touch with the management.
In addition, you can
consider getting the opinions of other shareholders about matters such as
competition, clients, and output to gain a better idea of the firm’s outlook.
This article was written by ForexLive at www.forexlive.com.