Welcome to the world of value investing! The main goal of this article is to get beginners into this world and give you a basic understanding of what value investing is all about. We'll start by understanding the core nature of investing itself.
Once you've got the concepts down, even if my articles aren't great, you'll know how to find the information you need.
The Origins of Value Investing
The concept of value investing was first introduced back in the 1930s by Benjamin Graham and David Dodd, and was later popularized and made famous worldwide by Warren Buffett and Charlie Munger.
So, before you start learning about value investing, let's first introduce these two pioneers, Warren Buffett and Benjamin Graham. A huge part of value investing is built on the foundation of their knowledge and wisdom.
Benjamin Graham
He's known as the "Father of Value Investing" and was one of the pioneers of modern security analysis and value investing theory. He was also Warren Buffett's teacher.
In 1934, he co-published Security Analysis with David Dodd, and in 1949, he published The Intelligent Investor. These two books are basically the bible for value investors and laid the theoretical groundwork for the entire field.
Graham's philosophy was built on the "margin of safety" principle, which is also known as the "cigar butt theory". To put it simply, it's about buying securities when their market price is way lower than their intrinsic value, which cuts your risk and boosts your potential return.
Warren Buffett
This guy is a huge deal—a world-famous value investor and one of the most successful investors of all time, often called the "Oracle of Omaha".
Early on, Buffett's investment style was heavily influenced by Graham. He made his fortune by holding stocks for the long term and focusing on a company's intrinsic value. He hasn't just seen huge success in investing; he's also widely respected for his simple lifestyle and charitable giving.
In his early career, Buffett followed Graham's "cigar butt" theory, buying just about any company as long as it was cheap. Later, after meeting his right-hand man, Charlie Munger, he revised his philosophy to: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price".
I'm guessing that even if you're a total beginner, you've probably heard of Buffett.
What is Value Investing?
For the value investing school of thought, a stock doesn't just have a price; it also has an intrinsic value tucked inside it. The idea is that as long as you invest for a long enough time, the price will eventually return to its value.x
The whole goal of value investing is to find a good company and buy it at a reasonable price!
Let's Talk About Price
"Price" is just the transaction price you see on the stock market. This price is the result of tons of buyers and sellers making deals. It represents the price point that both sides agreed on at that exact moment.
Does that sound a little weird?
Think about it: Let's say a stock's price is $100 right now. The buyer agrees to pay $100 because they think the stock will go up. The seller agrees to sell for $100 because they think it will go down. Both sides agreed that $100 was the "right" price for the trade, and that's the stock price you see.
Now Let's Talk About Value
"Value" represents the intrinsic value of the company behind the stock. The factors for figuring this out include how the business is doing, its future potential, the state of its industry, and so on.
An investor calculates a "fair value" based on the company's operations, which just means it's the price you think the company should be worth.
There are a lot of ways to calculate this value, and honestly, the number you land on is pretty subjective. Even if everyone uses the exact same method, they'll all come up with their own different "reasonable" prices.
The Core Ideas of Value Investing
The core idea is that sentence I just mentioned: "As long as you invest for a long enough time, the price will eventually return to its value".
In the short term, prices will jump all over the place. They might get super expensive or super cheap. But in the long run, the price will come back to the company's intrinsic value. So, your job is to find companies in the market that are undervalued.
Warren Buffett summed it up perfectly: "Price is what you pay. Value is what you get".
Europe's André Kostolany also came up with a world-famous analogy called the "dog-walking theory" to describe the relationship between a company's intrinsic value (or the overall economy) and its stock price. He said the owner represents the company's true value (its fundamentals), while the dog represents the stock price. No matter how far or wildly the dog runs, it will eventually be pulled back by the leash. Simply put, even though stock prices might drift far from the fundamentals in the short term due to market sentiment, speculation, or panic, they will always return to the company's true value in the long run.
Margin of Safety
There has to be a big enough gap—a "margin of safety"—between the price you buy at and the company's intrinsic value. By buying at a cheap enough price, you make that safety margin so wide it's like a moat. That way, even if you're a little off, you won't make a huge mistake. And if you're right, you stand to make an oversized profit.
Think Like an Owner
A stock represents part ownership in a company. When you buy a stock, you need to think of yourself as one of the owners. Pay attention to the company's development and its important financial numbers.
For value investors, the two most important metrics are ROE and Free Cash Flow. These show you if the company is still growing and if it's actually pulling in enough hard cash.
Hold for the Long Term
There's that sentence again: "As long as you invest for a long enough time, the price will eventually return to its value". For a stock's price to reflect its true value, you not only have to be right, but you must hold for the long term.
When the market crashes or soars, your job isn't to sell at the first sign of trouble. It's to regularly check on the company's business operations. If it still meets the conditions you bought it for, then ignore the market noise and keep holding. Or even better, use it as a chance to buy more while it's cheap!
"Long-term" doesn't have a precise definition in years. Look at it this way: no matter how much time passes, as long as the company's operations still meet your criteria, you keep holding until the price goes above the value you calculated.
I know it's not easy, but holding for the long haul is the key to making a profit.
Circle of Competence
"Know your circle of competence, and stick within it. Knowing where the boundaries are is vital".
What Buffett means here is: buy what you understand, and don't touch what you don't. If you understand semiconductors, go ahead and research TSMC or UMC. If you don't understand antique jewelry, don't invest in those types of companies, even if the charts look amazing.
Nothing is a Sure Bet
Even though value investing looks pretty safe, you can still lose money. That's why you have to really learn every step of the process, be selective about when you act, and lower your chances of making a mistake.
The most important thing is that you have to be crystal clear on why you're making a move. From the moment you buy, you need to know exactly why you bought it. The right time to get out is when that reason is gone.
