If you have spent any time in financial markets, you probably already know what Value Investing is. If you are new to investing, Value Investing is probably the easiest investment style to understand and apply towards your own investment purposes. Also, while debatable, some very successful investors have proven that Value Investing is one of the best ways to approach financial markets over the long term. Let me first illustrate what Value Investing is with a real world example.
Imagine that you are strolling through your local mall in the middle of July. The sun is scorching hot and you are just trying to stay cool. After your 3rd Caramel Frappuccino you decide to check out a nearby sports superstore. Shortly after you walk in you see something and you can’t believe your eyes. The snowboarding jacket you have always wanted, but were never able to afford is on sale. And not just any kind of a sale. It is a seasonal liquidation sale. Typically selling at close to $250 during the winter season it is now just $19.99.
You can’t believe how lucky you are. You check the jacket to make sure there is no big gaping hole in the back of it. Nope, everything looks fine. The size is just right. All zippers work and it’s the color you want. You are beyond excited. You found exactly what you wanted at over 90% discount to what it is really worth. The timing is not perfect and you can’t use it for the next 6 months, but you know with 100% confidence that you have found a deal of a life time. In 6 months this jacket will be selling at $200-250 again. Without a second of hesitation you take out your wallet and head towards the register.
Value Investing is just like that.
Except, instead of a jacket you are buying shares (or other financial instruments) in publicly traded companies. Basically, you do a lot of fundamental research to find companies that are selling well below their intrinsic or real value and then proceed to buy them at a significant discount. Typically 50-99% discount. The bigger the discount you can obtain the bigger your margin of safety is. In fact, margin of safety is one of the most important concepts when it comes to Value Investing.
Margin of safety is there to protect your capital. The theory suggest that if you buy stocks at deep enough discounts to their intrinsic value you have an automatic safety net built in. After all, no fundamental research can be 100% accurate and you need something to limit your downside risk. In such a case you are unlikely to lose a lot of money on your stock trade/investment because your investment is unlikely do decline that much further. Remember, it is already very cheap.
In essences you are buying $1 bills for $0.50 cents or less. Over time these assets “should” appreciate back to $1 to reflect their true value. Providing you with a large return on your investment while minimizing risk. Yet, as with anything, there are numerous issues associated with value investing. I will cover them in greater detail over the next few chapters.
For now, let me quickly summarize value investing in a five easy steps.
- Do a lot of fundamental research to find deeply discounted stocks or other assets.
- Buy such bargains or stocks at a significant discount to their intrinsic value. Typically a 50% or more discount is required. By buying at a significant discount you create a margin of safety.
- Margin of safety is your best friend. Maximize it. It protects your capital by limiting the downside.
- Patiently wait for asset appreciation to reflect its true value. Such periods can range from days to years.
- Watch your investment like a hawk by constantly updating your fundamental research. Should any developments alter your original investment thesis, you should re-evaluate your investment decision.
That about covers it.
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