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Value investing is the process of comparing the price of a security to the value it represents. The difference between price and value can present opportunities to investors and this is described as value investing.
Join our membership site today!What’s Value Investing?
Value investing means understanding that the price of a security is different to its value. The aim of value investing is to buy stocks that trade at a discount to their intrinsic value or earning potential. Investors can find stocks that they think the stock market is undervaluing using information about price and comparing the price with information on value taken from company annual reports.
It is based on the methods pioneered by Benjamin Graham and described in the book ‘The Intelligent Investor’. The most basic measure in value analysis is the relationship between price and earnings. Earnings are also referred to as profit. A company with a share price of 16 times the earnings per share might be considered fairly valued. The relationship between price and earnings is not the only statistic available to value investors, but it is one important way of allowing an investor to judge whether to invest or not.
Benefits of Value Investing:
Value investors are likely to get higher income streams.
For a given enterprise, which pays a dividend on common stock, or interest on a bond, a lower purchase price will provide a higher yield and, therefore, a higher income return to an investor. A high yield on its own is not a determinant of value, but a high yield with an understanding of the safety of the income stream will give better long-term income returns to investors. Investors can also make better investing decisions on lower-yielding securities by understanding the dividend history of common stock. Enterprises with a good history of growing earnings and growing dividends can be bought at lower yields on the understanding that a fast growth rate of the dividend will bring better long-term income returns.
Value investors tend to buy investments that are safer than investors using other investing methods.
The value analysis will identify whether the bonds or other debts create a risk for owners of any of the securities issued by a particular enterprise. Owners of common stock in particular, will want to know the value of any preferred stock or debt securities issued by an enterprise to assess the risk to the common stock owners from owners of these other securities.
Buying securities at low prices can provide protection to value investors, as the value of the assets of the enterprise may be more than the price being paid on a per share basis. Investors looking for a margin of safety will use a value approach.
Value investors are likely to have lower costs when managing investments.
Once the value analysis is complete, a value investor will know why a particular security can be part of an investment operation. This means that a value investor will only sell a security if the value conditions change. Short-term price fluctuations are unlikely to be reflected in the underlying value represented by the security, which tends to change much more slowly. Buying and selling securities frequently adds cost to an investment operation and makes it more difficult to make money from a set of investment operations. Lower investment costs lead to better returns.
Value investors are likely to get better long-term capital growth and ensure that an investor does not pay too much for either earning power or assets.
If an investor does not take a value approach, they have no idea whether the price being paid is cheap or expensive for the security involved in an investment operation. If a security is bought at a price that is ‘expensive’, it is very difficult to get any capital growth in the future. Value investing is one way of understanding the chances of future capital growth.
Value investors are likely to have lower anxiety about the short-term price fluctuations of the chosen security.
The analysis made at the point of purchase of a security means that if the price of a security fluctuates down, a value investor is more likely to be able to hold that security until the time the full value is realised. The understanding of the true value of a business enterprise or a security issued by that enterprise enables a value investor to ignore daily fluctuations in the price of that security or enterprise.
Features of Value Investing
The value analysis reports have the following features:
Size of the enterprise
Larger enterprises tend to be more resilient in difficult economic environments than smaller ones. Most of the value reports will focus on larger enterprises and will assess the size of the enterprise as valued by a stock market and consider the value of any long-term funding, such as long-term debt.
The nature of the financing of the enterprise
The value report will identify the levels of debt compared to various metrics to understand the enterprise's risk of not being able to meet its obligations. The purchase of common stocks and any security in an enterprise where there are more senior securities must be assessed in the light of the relative values of each class of security. Most of the value analyses on this site relate to common stocks, so the amount of debt and the cost of that debt is important for the value investor to understand d the margin of safety inherent in the purchase of common stock. The value reports indicate the margin of safety by analysing debt levels and the cost of any debt to common stockholders.
Dividend record
A common stock should have a good record of paying dividends when being considered as an investment. The dividend record will identify whether the enterprise has the financial resources to pay and grow a cash return for investors. An enterprise doesn't need to pay a dividend to be considered an investment by a value investor. However, a good dividend record is a great way for an investor to understand the capacity of an enterprise to create cash on top of all its other obligations, as an enterprise can only pay a dividend if it has the money.
Earnings record
This is sometimes referred to as profit. The assessment of earnings by a value investor covers two ideas. The true earnings record determines whether and how fast and whether the enterprise has managed to grow earnings. Ideally, the assessment of historic earnings should be at least ten years and show an ability to increase earnings. The second part of the earnings assessment is to consider whether the price being paid for the investment is good when weighed against the current earnings and historic growth of earnings. Paying too much for current earnings or the historic rate of earnings growth limit the ability to get capital growth from the ownership of an investment.
Price versus assets
All enterprises will own physical and non-physical assets. There are various accounting rules for valuing these assets. The most important number for considering the value of the assets, after accounting for any debt, is shareholder equity, sometimes referred to as the net asset value. The value of shareholder equity can be compared to the security price under consideration to allow a value investor to see if the price being paid is above or below the value of the assets. Buying assets below the net asset value number can create good returns for investors.
The value investor reports provide two conclusions for value investors
It is helpful to differentiate between two types of value investors. The inexperienced or defensive value investor should only purchase investments that pass all the defensive value investor tests. The five defensive value investor criteria are assessed in the report, and a short conclusion is given for a defensive value investor.
A more experienced value investor, referred to as an enterprising value investor, can invest in securities even if one or more of the defensive value investor tests have been failed. The value investor reports will identify and analyse other statistics, which might be useful for a more experienced investor when making an investment decision. The most common numbers covered in the reports are Return on Equity and depreciation. These other statistics can allow for investment as long as the investor understands the implications of the statistic. A short commentary and recommendation for experienced investors are included in the report.
Purchase Reports
As well as becoming a member of our research reports, you can also purchase individual reports without signing up for an annual membership.
There are several factors to take into account when considering the purchase or sale of securities. If you are using these reports, it’s likely that you are not taking investment advice or financial planning from us.
We refer to two types of investors in the downloadable reports. You can refer to our types of investor page and decide which one fits you best.
Become A Member
You can sign up and become a member of our research reports. Our reports mostly focus on ideas to help investors purchase listed securities, which have good value characteristics. Occasionally, we will identify overvalued securities with warnings that value investors should avoid, sell or possibly short a particular security.
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