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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.
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About
The Author
David
Pakman has been writing about politics and
investing for years now, and runs the
websites www.heartheissues.com and http://pakman.thevividedge.com |
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