Value investing is sometimes misunderstood that several investors end up putting money into low-priced investments that are not popular or attractive at the moment.
In fact, value investing involves choosing quality assets in a calculated manner and having the determination to go against the flow. To better understand this investment method, here are a few rules to follow if you plan to practice value investing.
Be Aware of the Investment's Intrinsic Value
Many investors rely on stock price movements to decide whether they should buy or sell their holdings. On the other hand, value investors usually believe a stock price can be similar to its intrinsic value in the long run.
As a result, value investors see an opportunity to purchase a stock at a discount when it is trading for less than its underlying value in the market.
A stock's intrinsic value can be determined in several ways. You can use a simple price-to-book (P/B) ratio to compare the company's market value to its book value. Typically, a P/B ratio under 1 means the stock is selling below the firm's net asset value (NAV).
Another simple metric is the price-to-earnings (P/E) ratio, which compares the company's share price to its earnings per share (EPS). A low P/E ratio often suggests that the firm is undervalued, making it a value stock.
If you're looking to be more specific, you can try financial metrics such as the price/earnings to growth (PEG) ratio and the enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) ratio.
Note that while there are various ways to calculate an investment's intrinsic value, value investors don't rely on the stock's market price alone to decide what they will do next. Rather, determining the intrinsic value is a crucial factor for them.
Calculation Over Speculation
Economist and father of value investing Benjamin Graham teach in his book The Intelligent Investor that value investing is an investment method that requires fundamental analysis and in-depth research.
In addition, value investing aims to minimize the risk of permanent capital losses and allow investors to turn a decent profit instead of putting money into risky investments that are not certain to provide adequate returns.
Considering those features, you can say that value investing is anything but speculative. Instead, it is calculative, qualitative, and somewhat predictive.
Avoid Going with the Flow
Value investing focuses on the opposite end of the market noise. That is because stock prices usually trade below their underlying value when the majority of investors have their attention elsewhere.
Value investors often take the route different from the one chosen by most investors. While that may seem like a not so wise decision, being certain of your choices matters more than being afraid of looking like an irrational investor.
Not every investor can be a contrarian player in the market, although it is essential to be one if you're looking to thrive as a value investor.
Have a Good Grasp of the Investment
Stock selection is a big part of value investing that separates it from other investment strategies.
In choosing potential value investments, you need a good amount of information about the asset and the company. That includes knowing the type of business the company engages in, its industry, competitive advantage, etc.
It's also important to keep up with any developments that may affect the firm. You can do that by reading and analyzing the company's financial statements and quarterly analysts' calls or getting in touch with the management.
In addition, you can consider getting the opinions of other shareholders about matters such as competition, clients, and output to gain a better idea of the firm's outlook.
