What Exactly Is Value Investing?
By Shawn Seah
There are many people who do not know the correct way to invest, as preached by Ben Graham and Warren Buffett. They confuse investment with speculation, day trading, dumb luck, chance, and in some cases sheer nonsense.
Value investing is an investment paradigm that focuses on a stock's true value rather than on the price movements in the stock market. Speculators bet on stocks going up and down, and there is scant difference between that and sheer gambling. Technical analysts invest money in stocks by looking at the price movements up and down, and making conclusions about where prices are headed before buying and selling. Value investors, on the other hand, just make simple decisions: are the companies in question worth buying? Is there a "margin of safety" between how much I am paying for a stock and what the company is actually worth? It looks simple but it is not, because analysing what the true value of a company is, called fundamental analysis, is very difficult and in some cases an art more than a science. It is simplified, but value investing can be taken to be simply about two key concepts, among others: margin of safety and fundamental analysis. I will be talking about margin of safety and fundamental analysis here.
Imagine a truck going over a bridge. If the truck weighs 1000 kilograms, you would want the bridge to be able to hold at least 2000 kilograms. You would not have a bridge that could only carry 1000 kilograms, because if anything went wrong, the truck would fall over and go into that steep ravine. This is the commonest expression of the key concept of margin of safety. A true value investor would like to have a difference between what he pays and what the company is actually worth. To augment this truck analogy, just remember Warren Buffett's wise saying: "Price is what you pay; value is what you get."
Now, the problem is, understanding that buying a dollar for fifty cents is a good thing, for that is what margin of safety is about, but what next? How do we actually determine how much a company is worth?
This is fundamental analysis. We look deep into the innards and inner workings of a company in order to divine its true value. Does it make money every year? We look at the financial statements and the income statements. What assets does the company own? We look at the annual report to look for net asset value and for the physical assets that the company has, all listed within. Who are the directors? We look at their names and their positions and ask ourselves if they get paid too much, are they reliable, are they expanding the company, are they giving out dividends and the like. Asking questions and using the annual report as a basis to find out answers to those questions is the heart and soul of fundamental analysis. Not only that: questions like what is the general economy like, what are people interested in nowadays, and what are interest rates and how do they affect the economy... these are other related questions that help us understand the factors influencing a company, fundamentally.
In short: margin of safety and fundamental analysis are key to value investing. Research well into the workings and finances of a company, get one with value, and buy it for a cheap price, and voila - you're the next Warren Buffett. Of course, it is not as easy as that and there are many complications along the way, but this is the gist of value investing.
I strongly recommend finding out more about value investing.
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