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An Introduction to Value Investing

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What is Value Investing?

In order to consider whether or not value investing is for you, assuming of course you have spare funds and a tolerance to risk, it is necessary to first examine the big difference between this and other forms of investing.

The 'fathers' of value investing are widely accepted as being Benjamin Graham and David Dodd. These individuals taught their philosophy at Columbia Business School in the 1920s and inspired a generation of hugely successful value investment practitioners, including the legendary Warren Buffett.

If you find share charts difficult to interpret, then you will be glad to discover that the long-term strategy advocated by Graham and Dodd does not involve their use. The reason for this is that they did not believe in the efficient market hypothesis, which is central to all chart use. This hypothesis states that stock prices have already taken into account all of the information about a company. Value investors disagree with this and base their whole investment philosophy on the fact that shares are sometimes under-priced due to market conditions.

Think of it this way, if you knew a car was worth $1000 and you saw it for sale at $650, then you would struggle to argue that this was not well worth buying, from a strictly monetary point of view. Well, this is essentially what Graham and Dodd were teaching. They urged their students to arrive at investment decisions based on calculations in order to arrive at an intrinsic value of any share. If the share proved to be selling below its intrinsic value, then this was a potential value investment.

The way in which these intrinsic values are calculated varies considerably, but they are not so complicated as to require advanced mathematics in order to arrive at them. Information such as price/earnings ratio, earnings yield and return on capital expenditure are all widely available, especially since the arrival of the internet as a serious investment research tool.

Value investors are contrarian. They do not follow a 'herd mentality' as they are far more concerned with their own assessment of the true worth of a company. They examine the fundamentals of a business and seek a price which is low enough to justify purchasing shares, viewing the practice of owning shares as claiming a percentage of ownership in a company. Their belief is that a share which is purchased below its intrinsic value will, over time, realise its true value, assuring a long-term profit.     

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Comments

Sep 29, 2014 9:57am
investmentcollege
Good overview of value investing! Do you know how to actually value a company and figure out if its below its intrinsic value?
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