Value investing is one of the fundamental concepts related to growing wealth. If you hope to earn money over the long haul, value investing can be one way to boost your potential earnings.
If you are interested in developing a strategy around value investing, here’s what you need to know:
Never Pay Full Price
Value investing is all about — wait for it — finding value. With value investing, the thought is that you can find an intrinsic value to an asset (usually a stock). Once you have arrived at that value for an asset, you try to buy it for less.
Think of it this way. You plan to make a major purchase, like a computer. You don’t rush out and pay full price. Instead, you shop around. You compare the computer’s price to other prices. You compare different models, looking for a good deal. Finally, you try to buy the computer when it’s on sale. You don’t want to pay “full price” for the computer.
It’s the same way when investing. Look at the asset and compare it to others in its class. Look at other fundamentals of the asset to determine whether or not it is priced below its value. The idea is to snap something up when you can get a good deal.
Remember the Margin of Safety
It’s not enough to get a 10% discount on your asset. Instead, value investing relies on the margin of safety. This is an extra buffer to ensure that if the asset doesn’t perform like you expect, you can still take a profit. Benjamin Graham, considered the father of value investing, recommended making a purchase only when the stock was at two-thirds or less of its value.
Benjamin Graham, considered the father of value investing, recommended making a purchase only when the stock was at two-thirds or less of its value. Using this guideline, if you put a stock’s value at $100, you wouldn’t buy it unless you could get it for $66 or less.
That way, if the stock didn’t perform as well as you thought, maybe only rising to $80, you are still better off. If you have analyzed the stock correctly, there is a good chance that it will rise in value over time.
When looking for value investments, it can help to wait for a market event. In these cases, most assets are falling in price, and it’s easier to scoop up value. Remember: value investing principles don’t include the efficient market hypothesis. So there’s a good chance that you can find assets that are undervalued and profit down the road.
Patience and Persistence are Key
It’s important to understand that value investing is a long-term strategy. If you are following this concept, you have to be prepared to stick with an asset for a long period of time. The idea is that you buy something that you think has long-term value and potential and that the market doesn’t value as it should. Then you hold it as long as you can.
When you engage in value investing, it’s important to stick with your plan through market downturns and difficulties. If the fundamentals haven’t changed, then there’s a good chance that your choice will weather whatever difficulty it faces. However, you need the patience to see it through.
At some point, you will sell your value asset, but only when it makes sense for your long-term plan, or if the asset has reached or exceed the value you believe it has. In some cases, the fundamentals of an asset do change. A company might change management, or it might go in a new direction that means lower profits. In these cases, it can make sense to sell ahead of schedule. (This is also why a margin of safety is important. It can limit potential losses.)
Value investing can be a great way to invest over time. If you are interested in picking stocks, or building a portfolio of other assets, this strategy can be a way to help you evaluate additions. However, it’s important to keep in mind that nothing is fullproof. You are investing, so you could still lose money. Make sure you plan accordingly and only invest what you can afford to lose.