Value Investing: A Simple, Quick and Easy Overview

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1.
Value investors buy stocks which are out of favor- for no sound or rational reason - with other investors: when a stock falls from grace, its price can also fall, making the stock cheaper than perhaps it ought to be.
2.
Having identified an unpopular stock/business, the value investor analyzes the company's underlying key financial fundamentals to assess the stock's intrinsic worth.
3.
If the analysis leads the investor to believe that the stock's price should be higher than it currently is, then the stock becomes a 'potential' buy 4.
The difference between a stock's current price and its intrinsic worth is known as the 'Margin of Safety' (MoS).
The higher the MoS the more attractive the stock is to a value investor.
A high MoS helps protect the investor's capital against any financial miscalculations and provides a cushion against any market downturns.
Provisos:
  • Different investors use different fundamentals, combinations of fundamentals and sometimes qualitative research to determine a stock's intrinsic worth: there is no universally accepted technique for calculating that figure.
  • The MoS does not have to be a fixed percentage.
    For large cap or blue chip stocks, or indeed a business the investor knows well, the investor may be prepared to pay 90% of intrinsic worth - i.
    e.
    a 10% MoS: for riskier stocks such as mid and small caps, the value investor may require a 50% discount to intrinsic value, which provides a MoS of 50%.
    The higher the desired MoS, the fewer stocks there are to choose from.
  • The experienced value investor knows that all that glitters is not gold.
    What all value investors must be mindful of are 'value traps'.
    Stocks can be cheap for less than obvious reasons.
    So even though the fundamentals may be attractive, purely quantitative analysis cannot (by definition) take account of qualitative matters such as poor management, market trends, the arrival of new and aggressive competitors, diminishing business prospects or out-of-date products.
  • Value investors like profitable companies.
    Not only will the investor check the company's record over at least five years, they'll also look at the consistency of the company's performance.
    High profit margins prove that the business knows what it's doing, whereas steadily increasing profit margins show that management is skilled at controlling expenses.
  • The value investor prefers to invest in companies which have been trading for at least 10 years.
    In that time, the business should have built a strong brand, be well established in the market, dominant in its chosen markets and have developed a substantial customer base.
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