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Value Investing
By David Pakman
By definition, value investing is the process of selecting stocks that trade
for less than their intrinsic value. A value investor typically selects
stocks with lower than average price-to-book or price-to-earning ratios. Of
course, it is not nearly this simple. Value investing is the corner stone of
long-term growth. Those who practice it survive the ups and downs of the
market and are more likely to emerge wealthy than those who ride the market,
in principle, due to the higher quality of the companies falling under the
prerequisites of the value investor. Value investing is essentially
concerned with getting the most profit at the lowest cost. The basis of
value is profit. Value investing is an investment style which favors good
stocks at great prices over great stocks at good prices. Value investor
extraordinaire Warren Buffett has used this style to become a billionaire.
It's important to keep in mind that value investing is not concerned with
how much the price of a stock has risen or fallen necessarily, but rather
what is the "intrinsic" or inherent value of the stock, and is it currently
trading below that price, i.e. at a discount to it's intrinsic value. The
important point here is that when looking at stocks that are trading at or
above their intrinsic value, the only hope for gaining value is based on
future events, since the stock price already represents what the company is
worth. However, when dealing with stocks that are undervalued, or available
at a discount, unforeseen events are unimportant in that without any new
earnings or additional profits, the shares are already "poised" to return to
that inherent value which they have.
The question now, of course, is "why would stock prices not always reflect
the true value of the company and the intrinsic value of its shares?" In
short, value investors believe that share prices are frequently wrong as
indicators of the underlying value of the company and its shares. The
efficient market theory suggests that share prices always reflect all
available information about a company, and value investors refute this with
the idea that investment opportunities are created by disagreements between
the actual stock prices, and the calculated intrinsic value of those stocks.
Finding Value Stocks
Value investing is based on the answers to two simple questions:
1. What is the actual value of this company?
2. Can its shares be purchased for less than the actual (intrinsic) value?
Clearly, the important point here is, "how is the intrinsic value accurately
determined?" An important point is that companies may be undervalued and
overvalued regardless of what the overall markets are doing. Every investor
should be aware of and prepared for the inherent market volatility, and the
simple fact that stock prices will fluctuate, sometimes quite significantly.
Benjamin Graham has often said that if investors cannot be prepared to
accept a 50% decline in value without becoming riddled with panic, then
investing may not be for them...or rather, successful investing, as it often
takes significant losses in a particular security before gains are made, due
to the idea that value investors do not try to time the market, and are
focused on the underlying fundamentals of the companies. Furthermore, the
quality of the companies targeted by the value investors' screening methods
should be, over the long term, less volatile and susceptible to market
"panic" than the average stock.
This is also a two way road of sorts. On one hand, there is no sense in
worrying about depressions, upturns, and recoveries due to the underlying
quality of the value investments. On the other hand, investments should only
be made in companies which can flourish and do well in any market
environment. Doing solid investment research and making equally solid
investment decisions will take investors much further than trying to
forecast the markets.
How Many Different Stocks?
In terms of diversification, there are many discrepancies over exactly how
many different stocks a solid portfolio should be made up of. My personal
view is that there should not be as many stock as normally make up a mutual
fund. Many will disagree with this, but what it's worth, I think that owning
a portfolio of 100, 200, or even more companies not only serves to limit
risk, but it really limits the possibility for reward as well. Also, as
Warren Buffett has said many times, the more companies you own, the less you
know about each one.
As I write this, there are 42 stocks in our recommended portfolio. This
number may very well grow in the coming months, as it may decrease in
number, but one thing to keep in mind is, out of the thousands of companies
available for purchase, only a very small percentage meet the stringent
requirements of the diligent value investor. This is both a blessing and a
curse. Very often, there is simply nothing to buy, and this is fine. The
trap to avoid falling into is to lower your requirements for a stock when
there simply isn't anything meeting the normal requirements. This is how
many an investor has fallen into making poor investment decisions, putting
money into companies not really adequate for their respective portfolio, and
it will certainly have a long term effect on gains.
David Pakman has been writing about politics and investing for years now,
and runs the websites www.heartheissues.com and http://pakman.thevividedge.com
Article Source: http://EzineArticles.com/
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