Friday, November 29, 2013

Value Investing through Sectors

The Sector-Value Investment Philosophy

The Sector-Value Investment Philosophy
By Steven M Wizior

When you think of value investing, you instantly think of Warren Buffett. Buffett studied at Columbia Business School. There he met his teacher, Benjamin Graham, who was the pioneer of value investing. Graham published his book "The Intelligent Investor", which goes into depth about value investing. Value investing is an investment philosophy that allows an investor to buy an equity/stock at a cheaper price than it is actually worth. Graham coined the phrase "margin of safety". What does this mean? Margin of safety is a term used in fundamental analysis; it means that a stock has a limitation of how much it can fall in price.

In value investing, the key theory focuses on the long-term. So a person would buy a stock and hold it for years or even decades. The stock's value would increase over time, based on global demand and population growth. Buffett always buys high-quality companies which are simple to understand. Additionally, Buffett always warns investors not to "trade" stocks because moving in and out of positions considerably increases risk and commission-based costs.

So, how do you find a stock with a margin of safety? It deals directly with fundamental analysis. One way to find the margin of safety is using the P/E ratio (Price-to-Earnings Ratio). Another is the P/B ratio (Price-to-Book Ratio). These two fundamental analysis tools permit an investor to attain shares of an undervalued stock. Other tools you can use include the P/S ratio (Price-to-Sales Ratio) and PEG ratio (Price-to-Earnings-to-Growth Ratio). All of these tools are used by Buffett and other successful value investors, such as Charlie Munger and Stephen Jarislowsky.

Now, what exactly is sector-value investing? It is an investment paradigm that employs an even more conservative approach than traditional value investing. When engaging in sector-value investing, an investor will only acquire stocks in principally non-cyclical, low risk sectors. For example, you would invest in a company that does not focus on Research and Development (R&D). Furthermore, you would avoid companies that do not own physical assets.

In the world of investing, many times the phrase "hard assets" arises. Hard assets include top quality brand names or physical assets such as real estate, power plants, pipelines, equipment and vehicles and/or vessels. Conversely, there are sectors such as technology and biotechnology. What do they exactly own? How much money do they spend on R&D?

Sector-value investing predominantly focuses on sectors such as real estate, banking, oil/gas, railroads, shipping, electric/gas production, consumer goods/services and manufacturing. This philosophy focuses on industries that have been around for decades and even centuries. They allow a company to always fall back on their assets in order to build up excess capital in case of an emergency.

Whether you use traditional value investing or sector-value investing, both philosophies work well over the long-term. They allow an investor to own part of top companies and re-invest their dividends over time, which eventually creates a gargantuan return on the initial investment. Many wealthy investors have used this technique for decades and will continue to do so in the foreseeable future.

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