Stock markets are the most volatile form of investment as compared to many other investment options that have relatively lower risks or are risk-free. However, the rewards in the stocks markets often justify these risks. There have been multiple cases of investors doubling their wealth and even more through careful and informed investments in the stock markets. For this investors need to have a good investment strategy and a thorough understanding of the stock markets. These strategies help the investors to make sound investment decisions so they can enter and exit the markets at the most optimum time to maximize their wealth or minimize their losses.
Value investing is one such popular investment strategy. Discussed below are the basic meaning and related details of value investing.
What is the meaning of value investing? How is it done?
Value investing is a century old investment strategy that was first introduced by Benjamin Graham in the year 1920. This strategy focuses on making higher returns by investing in stocks that are valued lower than their intrinsic value. This implies that the investors have to focus on the fundamentals of the company and firstly calculate the intrinsic value of the stocks.
This value is then compared to the current market price of the stocks to determine if they are undervalued or overvalued. If upon comparison, the investors determine the stocks to be undervalued backed by strong fundaments and a good growth trajectory, such stocks are picked under the value investing strategy.
The inherent assumption for such an investment strategy is that the price of the stocks is not always in sync with its fundamentals on account of extreme market volatilities. Therefore, investors have to analyze the fundamentals of the company based on various parameters like its P/E Ratio, P/B Ratio, EPS, EBIT, and EBITDA. These parameters allow the investors to assess the financial position of the company as well as determine the future projections ultimately giving a fair idea of its market position.
What are the pros and cons of value investing?
After learning the basic meaning of value investing, let us understand the pros and cons of this concept.
Pros
Some of the key advantages of the concept of value investing are mentioned below.
- Fundamental analysis based investing
This strategy involves the use of various tools and ratios to undertake a thorough fundamental analysis of the stocks or the asset before investment. This fact-based investment strategy is better than mere speculation where the chances of making a loss are potentially quite higher.
- Good opportunity to buy quality stocks at a low cost
The concept of value investing helps the investors focus on stocks that are undervalued. The current market price of such stocks is therefore at a lower level than what it actually should be. This allows the investors to accumulate good quality stocks at relatively lower costs which ultimately adds to the returns on the investment in the long term.
- Time tested strategy
The strategy was first introduced in the year 1920 and is still widely used by most investors across the globe. This is a time-tested strategy and therefore still quite popular despite many new and dynamic strategies available in the modern world. Therefore, new investors can rely on this strategy and then take a plunge into speculation once they have gained enough experience.
Cons
While there are many advantages of the value investing strategy, it also has its own set of disadvantages or shortcomings. Some of the key disadvantages of value investing are discussed below.
- Longer holding period
One of the prime disadvantages of value investing is the time period needed for the investment to be profitable. For an investment to be profitable under the value investing strategy, the value of the stock should be equal to its intrinsic value or higher than that. The usual holding period for such stocks is anywhere between 5 years to 7 years. This may not be ideal for investors that do not have such long time investment horizons or are looking for short-term gains.
- Risk
The risks of investing under this strategy are quite high. The investors need to calculate the intrinsic value of the stocks to determine if the stocks are undervalued or overvalued. This calculation can be difficult to understand and compute for average investors. Any minute mistakes in the calculation can lead to erroneous investment decisions that can damage their overall portfolio in the long term. Also, despite a company having good fundaments, it may not progress further due to certain unforeseen circumstances or developments and the investment may not yield good returns. This fact also has to be considered by investors while selecting a stock for investment.
What are the factors to consider while picking stocks based on the value investing model?
After understanding the basics of value investing, it is also important to know some key factors to be considered while using this strategy. Some of these factors are mentioned below.
- Intrinsic value is the prime factor that needs to be understood and calculated for value investing strategy. If this basic step is not understood and calculated correctly, the investors will not be able to make correct decisions under this strategy.
- Investors need to understand the basics of fundamental analysis and the various ratios that need to be computed and assessed under value investing strategy. This will help them select quality stocks that are undervalued rather than simply selecting stocks based on herd mentality.
- Value investing strategy is a good option for investors with a medium to long-term investment horizon. Investors should consider this factor while selecting this strategy and not have any unrealistic expectations in the short term.
What are the key differences between value stocks and growth stocks?
The key differences between value stocks and growth stocks are highlighted below.
| Category | Value investing | Growth investing |
| Meaning | Under this strategy, investors seek stocks that are undervalued and invest in them to earn potentially high returns in the long term. | Under this strategy, investors seek companies that are on a high growth trajectory and deliver returns higher than the industry average. |
| Dividends | Value stocks generally provide consistent and higher dividends | Growth stocks do not provide consistent or high dividends |
| PE ratio | The PE ratio of stocks under this strategy is generally lower | The PE ratio of stocks under this investment is generally higher. |
| Current market price | The current market price of the stocks is lower than its intrinsic value | The current market price of the stocks is higher than its intrinsic value. |
| Target investors | The target investors under the value investing are risk-averse and have long term investment horizon | The target investors under growth investing are aggressive or dynamic and have a short term investment horizon |
Conclusion
Value investing is one of the oldest investment strategies that are still relevant and will also be useful for investors another 100 years down the line. The concept of value investing is fundamental-based and hence it will never go out of fashion and continue to help investors make profitable investment decisions.
FAQs
The key ratios to be considered under value investing are PE ratio, PB ratio, EPS, EBIT, etc.
A low PE ratio of stock under value investing strategy signifies that the price of such stock is low and undervalued.
No. For selecting stocks under value investing, investors need to undertake a thorough fundamental analysis of their target stocks and hence herd mentality can be detrimental to their interest in such cases.
Yes. Diversification is the key to having a profitable portfolio with manageable risks. Hence, investors can target stocks under various categories like large-cap, mid-cap, and small-cap to diversify and balance their portfolios.
