The value investors adhere to a principle of buying only undervalued stocks. They are undervalued in a sense that their current price fails to reflect their fair market price or the true intrinsic worth. The major reason why value investors look for undervalued stocks is because the value stocks tend to offer a higher degree of capital preservation as compared to growth stocks. The value investors are not much concerned with how much they can make with an investment, but they are concerned with, how much capital they could lose. For instance, after buying a stock, what are the chances of price falling, and never mind rising?
The followings are some of the major principles of value investing. If you want to know how you can earn with this investment approach, you are advised to continue reading with full concentration.
- Every share of stock is the ownership interest in an underlying business. Stocks are not pieces of paper that one can sell at higher prices on future dates. Rather, they represent more than just a right to receive the future cash distributions from the company. Economically, every share is an undivided interest in corporate assets and ought to be valued as such.
- Stocks have intrinsic value. The intrinsic value of stocks is derived from the economic values of an underlying company.
- The stock market is inefficient. The value investors do not subscribe to the efficient market hypothesis. Rather, they believe that the shares trade hands frequently, at a lower or higher price than their intrinsic values. However, seldom the difference between the intrinsic value of a share and the market price of that share is wide enough to permit the profitable investments. The father of value investing Mr. Benjamin Graham explained the inefficiency of the stock market by employing a metaphor. Even today’s value investors still reference his Mr. Market metaphor.
- Investing is most intelligent when it is most businesslike. This quote is given by the Benjamin Graham. According to Warren Buffett, this is the best investing lesson. Investors should treat investing with studiousness and seriousness to justify their profession. Investors should treat stocks they buy and sell, just like shopkeepers that treat merchandise they deals in. They must not make commitments where their knowledge of merchandise is insufficient. Moreover, they must not engage in investment operations without doing reliable calculations that show fair chances of yields and reasonable profits.
- True investments require a margin of safety. The margin of safety may be provided by a company’s working capital position, economic goodwill, land assets, past earnings or a combination of some of these all. The margin of safety is manifested in the difference between intrinsic value and the quoted price of a company. Furthermore, it has the ability to absorb all the damage that is caused by the inevitable miscalculations of investors.