Getting Started with Value Investing
If you’re new to the world of value investing this page is for you! It contains the information you need to get up to speed quickly and start investing with confidence!
Value Investing: The Value Investing Headquarters Definition
Value investing is an investing approach that aims to buy quality businesses that are well managed, have a competitive advantage, and happen to be undervalued by the market. Notice that I said that you would be buying a “business” instead of a stock. Although you will technically be buying the stock in a company the mindset of a value investor is to analyze the business itself and think of it as if you were becoming an owner of the entire business. With that point of view you will be concerned about what the company does, how much debt it has, do people like or need it’s products, and other fundamental facts about how it operates.
What Value Investing Is Not
It’s also important to know what value investment is not so that you can course correct if you find yourself straying from your strategy.
- Market Speculation
Trying to guess what the market is going to do and when on a day-to-day basis is a losing battle. You will never be able to do that effectively or consistently, and if you do it’s luck not skill. The future is uncertain; there are products that no one has thought of yet, technologies that will change how business is done, and a whole lot of other things that affect the market such as natural disasters, wars, supply shortages, social unrest, and a bunch of other events that are unpredictable.
- Technical Analysis
Technical analysis is an investing approach that looks at charts and other tools to look for patterns in the historical price of the stock to arrive at a conclusion as to where you think the stock price will go in the future. This methodology tends to be based on the behavior of other investors as it relates to the stock, and less about the company’s intrinsic value.
- Get Rich Quick Scheme
You may become the next Warren Buffett if you follow a disciplined value investing approach, but it won’t happen overnight. It will require a methodical approach to research and an avoidance of following “hot stock picks” that you will hear about in cable news shows. In fact if you want to be a successful value investor you should probably turn off the television. Watching daily financial headlines about market gyrations is a sure way to make you panic and abandon the strategy that you spent all that time researching.
What to Expect with Value Investing
Value investing requires that you do the leg work to determine if a business is worth buying. That means that you will be doing some research, and you will need to get comfortable reading financial statements. Determining the intrinsic value of a company is a key piece of any value investing decision (how else will you know if you’re getting a good deal?), and getting familiar with those calculations will be instrumental to getting comfortable with your investment choices.
Sometimes buying a stock will be a decision that you make when everyone else is doing the exact opposite and selling that same stock. We like to call that gut-check time since at the moment of purchase you may wonder if you missed anything, or why would you ever want to buy a stock that few people like. Value investing will require that you get familiar with the following concepts.
- Intrinsic Value
Intrinsic value is used to determine whether a stock is trading at a discount (which is when you should buy it), or if it’s over priced. There are various ways to calculate intrinsic value, but one of the most popular is to use a discounted cashflow model. This approach requires that you analyze the company’s Free Cash Flow and make a couple of assumptions about projected growth and risk.
- Margin of safety
To feel more confident that you did your due diligence you will always want to make sure that you calculate another value, the Margin of Safety. What the margin of safety basically tells you is that if you did miss something in your research, it allows you to pad your assumptions so that you don’t get burned by your oversight. So the bigger the margin of safety the better you can feel about the assumptions you made in getting to an intrinsic value for the company.
- Economic Moat
An economic moat in value investing is defined as the company having a competitive advantage that is not easily replicated by a competing firm. With such a competitive advantage a competitor might be discouraged from spending a lot of money to close the gap to eliminate that competitive advantage. For example, the market for the fertilizer mineral potash is large since it is one of the only plant nutrients that increases the yields in corn fields and there is no easy substitute that is as effective. Companies that produce that nutrient have a client base that can’t go without that mineral. If a competitor wanted to capture some of that demand and begin selling the same fertilizer they would first have to spend $2 billion to open a mine. Those costs might eliminate any potential profit that a competitor would get and may discourage them from entering the potash fertilizer market. Those constraints are what is referred to as having a wide economic moat.
Value investing is a long term strategy where value is captured when you purchase a stock not when you sell it. In some cases you may never want to sell a stock so you should do everything possible to make sure you’re getting a good deal before you buy the stock. If you think of your holding period as eternity, you’re more likely to do your due diligence on the company. It is for those reasons that you should get comfortable with reading financial statements and learning what story they are trying to tell you.
Some of this information can be overwhelming for a first time value investor, so we build tools to help you get started and track your assumptions. Our tools include:
- Intrinsic Stock Value calculator
This calculator looks up basic information about the stock and allows you to easily enter a couple of values to get an idea of what the stock’s intrinsic value should be.
- Gain/loss calculator
When you’re ready to sell a stock, this calculator will tell you how much you’ve gained (or lost) as a result of in investing in it.
- Mobile Web App
Accessed from a mobile device, the Value Investor Headquarters Mobile Web App will allow you to quickly calculate intrinsic values, and save stocks to a watch list that you can monitor to see if it’s the right time to invest in a stock you saved.
We’re always looking to enhance our toolset. If you have any suggestions on what you’d like to see or blog posts on value investing topics send us a note through our contact us page.
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