Filed Under (Web Hosting Company Information) by lake0801 on 19-10-2011
Investing has various styles; you can choose one based on what suits you best. While it is not necessary that one sticks to a particular style always it is a good idea to have an understanding of the various investment styles. Starting this week, we will take you through the various common investing styles.
We start off with the most popular style of investing ? `Value Investing`. Value investing, simply put, is the skill of identifying and buying an item worth Rs. 100/ at a rate less than 100. The key is in identifying that the particular article is actually worth Rs. 100/- (this is the intrinsic value)
Concept of value investing
Investors are always on the lookout for stocks of companies which they believe are undervalued. Such opportunities arise because markets tend to over-react to good and bad news, resulting in stock price movements that do not correspond with the company`s long-term fundamentals.
As suggested earlier, the challenge really is in identifying the intrinsic value. There are no fool proof methods for estimating the intrinsic value and 2 different analysts` could typically place varying intrinsic values for the same underlying stock. The cardinal concept that value investing revolves around is the `margin of safety`; this essentially means that the investor should buy the stock at a heavy discount so that any error in estimation of value could be overlooked or will not matter.
Identifying value picks
The commonly used ratios for identifying value stocks are price-to-book or price-to-earnings. These ratios are typically compared alongside industry peers and lower than the average is chosen to be an ideal value pick.
Certain value investors dig deep into the past data and focus on the run rate of assets / earnings of the company and pay scant regard to potential for future growth. Certain others go the other way; base strategies completely around the estimation of future growth and cash flows. In fact, a balanced approach between current numbers and future potential is what is required to successfully execute value investing strategies.
At This point, it does not take rocket science to understand companies like Tata Motors and Reliance, to adjudge that these could be companies which will grow at a steady pace and provide returns in the form of regular dividend alongside capital appreciation. But for someone to have identified this potential some 10 years` back would have definitely taken some digging to be done. If someone had identified these very stocks when they were trading at lower than Rs. 100/-, some of the names would have grown ~7 times over the past 10 years`. These could have been typical value picks.
Pioneers of value investing
Benjamin Graham is regarded by many to be the father of value investing. He co-authored the all-time Bible of value investing `Security Analysis` with David Dodd which was first published in 1934. The most lasting contribution of this book to the field of security analysis was to emphasize the quantifiable aspects of security analysis (such as the evaluations of earnings and book value) while minimizing the importance of more qualitative factors such as the quality of a company`s management. Graham later wrote The Intelligent Investor, a book that brought value investing to individual investors and was more holistic in nature.
His student, Warren Buffett has taken the value investing concept even further with a focus on `finding an outstanding company at a sensible price` rather than generic companies at a bargain price. However, his style of investing was later dubbed as `Contrarian Investing` which has great resemblance to `Value Investing`. Apart from Warren Buffet, other students of Graham, William J. Ruane, Irving Kahn and Charles Brandes have gone on to become successful investors.
Market dynamics & value investing
Buying shares that are perceived to be value stocks in a bear market could sometimes lead to further downfall in that very stock, thereby dunking the stocks a notch lower than the intrinsic value that was calculated. The problem with not buying shares in a bull market is that despite appearing overvalued at one time, prices can still rise along with the market.
Therefore, you may not always hit bull`s eye with value investing, and this could be partially because of market inefficiency. Vale investing is inherently riskier and hence the expectation on returns is also significantly higher.
Suitability
This style of investing is suited for someone who has ample knowledge about markets and has the ability to dig through details to identify the nuances of the stocks under consideration. This strategy of investing can be used for individual stocks, whilst considering merger / acquisition, picking an asset class etc.
A typical value investor is one who has a good appreciation of the investing world and has the ability to assume a higher risk. We will discuss another style of investing in the next week. Happy investing!
(Contributed by Anil Rego, CEO & founder, Right Horizons) fmlht111019
Value investing: Finding the hidden gem!
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