Value investing is a form of investing in businesses which appear underpriced compared to the price it’s selling at in the stock market. Fundamental analysis (qualitative and quantitative) is done on the stock to determine if it’s a good business to own. It was founded by Benjamin Graham and it was later popularized by Warren Buffett, Benjamin Graham’s student.
There are basic 4 steps involved in value investing:
1st step: The company must have a competitive advantage or wide economic moat. Then, ensure that it is fundamentally strong by assessing its financials and reading up on the management.
2nd step: Once a good company is identified, determine the price to buy at by calculating its intrinsic value.
3rd step: Buy the company only if it’s trading below its intrinsic value. I usually buy if the current price is 25% below my intrinsic value and the 25% is a margin-of-safety (MOS) in case my calculations are not accurate. If price is not right, just wait on the sidelines and save up some money. Great buying opportunities are presented during a bad economic news, natural disasters, financial crises or a one-time solvable problem faced by the company.
4th step: Once the current price is below intrinsic value, scoop up the shares.
5th step: Sell when the price has hit your intrinsic value, fundamentals have turned for the worst or you have made a mistake.
Repeat steps 1 to 5 on other companies. Remember to always re-invest your dividends into the stock market to compound your money.
Value investing can be very fun once you get the hang of it. When you start off, it might seem tedious plugging in all the numbers to analyze the company. But after a few tries, it will become interesting and you can analyze companies almost instantaneously.
*The picture above shows Warren Buffett drinking his favourite Cherry Coke. He has invested a huge sum of money in Coke because it has a wide economic moat and is a fundamentally strong company. Even fifty years down the road, Coke will not go obsolete like technology does.