THE PRINCIPLES OF THE INVESTMENT STRATEGY SIMPLY EXPLAINED
Value investing is about buying undervalued stocks and betting on their positive development over the long term. For this purpose, listed companies are rated according to comprehensive operational and financial indicators and compared to their share price. Value investing is thus the counter model to short-term stock market speculation.
What is value investing?
Value investing does not see stocks primarily as an object of speculation, but rather as what they actually are: shares in a company. Since the price of a share is determined by free trading on the stock exchange, it depends solely on supply and demand among private and institutional investors. So it is not directly linked to a company’s performance, although it is often based on it.
This difference between the market value and the actual value of a company is used in value investing. You put the two values in relation to each other and you can identify companies whose shares are undervalued on the stock exchange. The investor therefore decides on the basis of his analysis that a certain company is worth more than its market value and predicts that the share value will rise in the long term for this reason.
So, when it comes to value investing, you’re only targeting undervalued stocks . One does not speculate on rapid price increases, but on solid performance. That is why value investing is an approach that is designed for at least a few years. Value investors earn not only from the difference between purchase and sales value, but also from dividends and possible share buybacks or company spin-offs.
The basic principles of value investing
Value investing basically comprises an entire investment philosophy that is difficult to reduce to a few basic principles. However, knowing the most important key ideas is helpful in understanding value investing.
Price ≠ Value: The safety margin
Without thorough fundamental analysis of the companies behind the stocks, value investing is impossible. This is the only way to tell whether a company is undervalued or overvalued on the stock exchange. The difference between the actual company value (intrinsic value, fair value) and the actual market value is referred to as the “safety margin”.
The difference between the actual value and the market value is the safety margin.
The profit lies in purchasing: Undervalued buying
The value investor assumes that his analyzes give him a knowledge advantage. In order to use this as well as possible, he invests in stocks that are as much undervalued as possible or have a high margin of safety. This increases the chances of winning and lowers the risk.
Buy & Hold: Long-term investments lead to success
Value investing assumes that in the long run the shares of successful companies will rise in price even though they are currently worth less. However, it is difficult to predict when this will happen or how quickly the price will rise. Therefore, stocks have to be held for a number of years. Ideally, they are only sold when the company’s valuation is significantly worse compared to the market value and the shares are therefore currently overvalued. Because then holding the shares for a longer period can only lead to losses.
What do value investors look out for?
Stocks that rank below their fair value are interesting for value investors. For a profitable sale it is then sufficient if more investors discover and invest in the potential of the shares in the future. On the other hand, price setbacks are less likely if the valuation was not previously inflated. In addition to stable, long-term sustainable business models, classic value values also show:
- a low price / earnings ratio (P / E),
- an attractive price / book value ratio (P / B),
- high and constant dividend yields.
THE PROS AND CONS OF VALUE INVESTING
Value investing is about identifying companies with potential and exploiting it. Value investing stands and falls with intensive analyzes of companies, their competitors and markets. In contrast to short and medium-term speculations, value investing therefore requires a larger database.
However, there are also disadvantages to value investing. First of all, independent value investing is difficult for private individuals to pursue. You have to deal very intensively with the company, acquire and internalize the basics of entrepreneurial activity. Only then are you able to create a fundamental analysis, evaluate it and then identify a promising investment – and even then there is no guarantee of a successful investment, because nobody can see into the future. In addition, there is usually a lack of prior knowledge and the corresponding capacity for analysis – after all, there are over 50,000 listed companies worldwide. Large investors, fund managers and investment banks have the necessary capacities. In addition, value investing is always a long-term approach and therefore assumes that the funds invested can remain in the investment over the longer term.
Who is value investing for?
Value investing or not? This is a fundamental question that every investor has to decide for himself. We have put together a checklist that you can use to check whether this approach is right for you.