The financial markets are often filled with irrational exuberance or extreme pessimism. This causes abnormal movements and fluctuations in the stock prices that do not correspond with the business value of the company.
Often, such market reactions serve as a good chance for investors to earn better profits by buying stocks at undervalued prices. It is no secret that value investors prefer those stocks that are trading at lower than their average price and the stocks with high yields in the form of dividends.
It is no secret that value investors prefer those stocks that exhibit these characteristics:
- Founder-led management
- Dominant market share in its market
- Stability in profitability ratios
- Healthy solvency ratios
- Provide good dividend yield for slow-growers or dividend plays.
Estimation of Stock Intrinsic Value
Estimating the stock intrinsic value is the most important aspect of value investing. Answering the following questions can help to determine the evaluation.
- What is the actual value of a company? What are its peers’ valuations?
You should know that there can never be an exact intrinsic value. Every investor can judge the intrinsic value of stocks differently. The margin of safety comes into play and suggests buying stocks at a certain discounted price so that you stay safe if an error occurs in the value estimation.
Choosing the Right Companies
The basic fundamentals of value investing roam around choosing the right companies. Evaluating the true value of new companies is very difficult so you can consider companies that are in business over a decade or two. Ideally, a company with a track record is safer.
Survivability is another important factor that one should consider. You are advised to see, whether a company can survive for another twenty to thirty years and if it seems that a company would not be around for very long, there is no terminal value in it. Is this industry being disrupted?
For example, we have seen how CD shops and bookshops are made redundant by the invention of Spotify and Amazon respectively.
Uniqueness is another criterion to consider in value investing. It is important to see the uniqueness of a company. You can consider these questions:
- If the company has any special copyrights, special patents or trademarks, to allow them to charge supernormal profits? For example, Pfizer (NYSE:PFE) holds certain trademarks in their Centrum and ThermaCare drugs.
- Do they have the process know-how or any form of indestructible intangible know-how? It forms their competitive advantage which their competitors are unable to imitate.
- How often does their Research & Development team come up with new products and services to meet the needs of its customers?
Value investing is considered one of the most successful and proven investment strategies. In the long run, such stocks are very profitable and safe when it is practiced correctly. According to different surveys and studies, stocks outperform bonds and other forms of investments.
Investment in stocks may be difficult and daunting. However, learning the basics of value investment through investment courses can make the first step much easier.
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author(s) involved in the writing of this piece does not have any current vested interest of the companies mentioned. If you require expert financial or other assistance or legal advice, a competent professional should be consulted. We are not affiliated to any of the companies mentioned except for a commercial relationship with ShareInvestor.