Value investing is the strategy of buying stocks trading at prices lesser than their intrinsic values. People who invest into such stocks are referred to as value investors and they actively seek stocks that have been undervalued by the market. They believe that market often overreacts to different news stories, leading to price movements that don’t reflect the actual long-term fundamentals of the concerned companies, thus providing an investment opportunity to these investors. As a result, value investors can purchase stocks at lower prices than normal.
Value investing requires a contrarian approach, apart from a long investment horizon. If we look back at the statistics of the past hundred years, we’ll notice that value investment strategy has outperformed various index returns across many equity markets.
Why it’s not easy
A major task related to value investing is correctly estimating the intrinsic values of different stocks. Please note, there is no specific correct intrinsic value when it comes to stocks. Two investors may place completely different values on a given company even if they’re provided the exactly same information. This is where the concept of ‘margin of safety’ comes into the picture. It implies that you purchase stocks at a discount big enough to give you some room for error in the value estimation.
Furthermore, value investing has a subjective definition, which varies from investor to investor. While some look only at the current assets/earnings ratio, without placing any value on the potential future growth of the company, others have entirely different strategies revolving around the future growth estimates and cash flows. Regardless of the methodologies used, it all boils down to the ability of buying something at a price lesser than its actual worth.
Why stocks may trade at discounted rates
Stocks may trade at discounted rates owing to several different factors. Nevertheless, the most commonly known reason is the short-term profit-related disappointment among investors. Many a times, such disappointments can also result in strong emotional reactions from the shareholders who may resultantly, sell all their holdings, fearing further negative results.
Value investors on the other hand recognize and place importance on two important facts. First, majority of businesses have a long-term perspective of their existence and the actual effect of such short-term setbacks is negligible on the long-term valuation of the businesses. Second, value investors recognize the fact that when viewed over the long term, poor profit results get gradually reversed and strong profit results tend to slow down with the passage of time. This is a powerful fact, one which is not easily believed by everyone.
Value investing is an art that exploits the irrational behaviour patterns of emotional investors. Emotion is always a constant feature when it comes to market investments. Even though the companies on offer may change from one decade to the other, the basic human nature of investors doesn’t. Fear and greed still have a very strong hold on everyone, just like they did a hundred years ago.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.