Dividend Growth Bunny: What is Value Investing: The Beginner’s Guide

Saturday, September 21, 2019

What is Value Investing: The Beginner’s Guide

Investing in stocks is considered to be one of the most powerful methods you can use to attain financial independence. However, it’s also a great way to lose your hard earned money if you don’t know what you are doing. In the stock market, many people have different strategy to invest. Some uses chart and technical analyst when picking a stock which can be considered to be speculating. Some prefers to invest in stocks as if they are investing in a business. This is where the term Value investing comes in.  It is like an art skills on picking a stock as an investment. Value investing is a strategy of which so appealing for beginners because it is designed to both reduce risk and unlock potential profits. It is an investing strategy that involves on how picking stocks listed in the stock market that appear to be trading less than or within their intrinsic value. The term was first inspired by Benjamin Graham who is the author of “The Intelligent Investor” and in some circles, he is known as the “Father of Value Investing”. Benjamin Graham was also a mentor to one of the most successful investor name Warren E. Buffett. With this method of investing, many investors had made fortune in their investing career. Some of the successful investors such as Peter Lynch, Joel Greenblatt, Ray Dalio, and many more had done very well using value investing method. These investors had used value investing principle when picking a stock to invest. Anyways, are you curious about this method of investing? If you want to invest in stock safely, I think value investing is the right investing method for you. In this content, I would share with you readers the investing method of Value Investing, and how you can apply this investing term to the way you invest in the stock market. Moreover, I would like to share why I use this method as my investing strategy to pick my dividend growth stocks to my portfolio holding.  

How Value Investing Works?
Value investing is considered to be intelligent investing. There are many factors why a stock might trade at discount to its intrinsic value. The most common reason was probably caused by the pessimism in the market, or it could be a short term disappointment of a company’s earning that made the stock trade in price that is remarkably low. Frequently these disappointment and pessimism can produce a strong emotional reaction in the shareholders who sell their stocks fearing further decline of the stock price. As a value investor, you want take this opportunity to purchase these stocks at a bargain as an investment.

Moreover, value investors understand that for every share of the company they purchase is like purchasing a small piece of the company. You worry less if the stock price goes down in price since you know the fundamental behind the company. If you are just speculating on a stock, a 50% drop in share price might worry you since you don’t understand what’s going on except to know that you lost 50% of your money. Imagine, you have $100,000 invested in a stock and you lose 50% of your account value. I’m pretty sure that you will be terrified, and will try to make irrational move by cutting your loss and having you to take the realized loss of $50,000. Also be aware, to cover back your lost require you to gain 100% on your left over $50,000 capital to get back to where you started. This is the reason why value investing is a great strategy for investor who wants to invest. They will understand the underlying value of each share of the company that is traded in the market.  

So How do Value Investor Know Whether the Stock is a Good Buy?
The way on how you can use value investing when picking a stock is to comprehend how the business actually operates. You need to understand how the companies’ management are like and how they generate their income. By understanding the basic concept of how the company runs gives the investor a broader picture whether the company has future growth or not. In addition, Value investors don’t focus on the short term nature of the business, but to see the long term and expect the business will survive decades ahead. For example,
Warren Buffett only invests in companies that he thinks they would still be in business in the long run. Value investor focuses on investing in quality companies that they think are undervalued or within fair value price range. You can determine the value of the stocks after you apply fundamental analysis within the companies. By applying financial metrics, you are then able to know whether the stocks are a good investment or a bad investment. Value investor sees value in a stock by looking at their valuation metrics, such as low multiples of their earnings or assets. These metrics can give you an indication whether the stock is trading at a reasonable or low price. However, you’ll still to be cautious on investing in a stock that is a value trap.

Taking Advantage of the Market Fluctuation.
Value investing seeks to exploit the irrational behavior of emotional investors who sell their share in the market. For instance, during the recession crisis that happened in the United States in the year of 2008 is a great example on when value investors used this opportunity to invest. Many emotional investors feared that the stock market would continue to decline and the companies’ stock they were holding would worth less. The market turmoil resulted that many great quality companies which had strong business model to be trading at an unreasonable cheap price. As a value investor, you should take this opportunistic time to purchase great companies at a bargain.

Value investors knew that the companies they picked would still be in business in the long run, and the fluctuation in the share price was just temporary and unjustified. A great illustration for this is like shopping in the mall during sales season. During this time period, merchandises in the retail store have great discounts. As a great value shopper, you want to take this opportunistic time to purchase your favorite clothes at a bargain price. I mean why buy the same clothes at retail price when you can get them at 50% off or more during sales season. This is the same to value investing. Value investors want to purchase stocks at a price that are on sales. This way, when the market recovers, the stocks will also eventually go up in value as well.

Why use Value Investing Method?   
After understanding about value investing, you readers probably want to figure out why you guys should use value investing method. The reason I’m going to give why you should use value investing is because it actually works. There are many successful investors such as Warren Buffett, Peter Lynch, Joel Greenblatt, and many more did very well for themselves. When I was an amateur investor back in College, I was picking stock without applying value investing (Speculating). It was really confusing for me to invest in companies just by looking at the chart movement. I have no idea how the company was performing fundamentally, and just looking at daily movement of the stock price can be terrifying if you don’t understand value investing. For this reason, I decided to learn more and share my own experience by applying value investing for the path I am investing. I am more confident with the stocks I’m holding now since I know the fundamental behind each stock. If you take a look at my portfolio, you can see some of my stock holdings are actually at unrealized loss. I’m not afraid that I’m losing money on that particular stock since I know the fundamental and value behind that share. In fact, I would probably increase my holding if I think the company is trading at a bargain.

If you are still not convince why value investing is the way to invest, there are many studies that prove applying value investing strategy actually outperform the market over the long term. Craig Israelsen published a study in Financial Planning Magazine in 2015 that showed the performance of growth vs. value stocks in all three market capitalization sizes over a 25 year period from the beginning of the year 1990 to the end of 2014. The return of the chart shows that large-cap value stocks provided an average annual return that exceeded large-cap growth stocks by about three quarters of a percent making the value sector as the winner. Furthermore, another study was done by Allgen. He built a diversified portfolio which contains both value and growth stocks. The chart I posted below shows the performance difference over the last 20 years between growth and value stocks. The study concluded that during the last 20 years, value stocks have outperformed growth stocks by a significant amount (71% total or 1.1% compounded annually). In addition, other studies that had been studied for 40 years period (between 1970 to 2010) shows that value stocks outperformed growth stocks by almost 3% annually.  

How do I use Value Investing in Purchasing Dividend Growth Stocks?
As a value investor, I myself am personally using this investing method when picking stocks that pays out dividends. I like the fact to know that the dividend stocks I’m investing in are companies that are trading at low or fair price to its intrinsic value. Furthermore, since I’m a dividend growth investor, I also want to hold these dividend paying stocks for decades so that I can receive the passive income (dividends) that they are paying out quarterly. I pay attention to market overreaction to current events and to which companies pay dividends. Companies that are undervalued based on their long-term growth potential could be potential stocks I will intend to purchase as an investment to my portfolio. My goal is to have a dividend growth portfolio that produces the income stream that can be used to be reinvested or spent during my early retirement. I hope the dividend stocks I’m currently holding will eventually increase their dividends and appreciate in value over time. This will then increase my overall asset (wealth) as well as passive income stream (dividends) in the future. Hopefully, by using value investing method in picking quality dividend stocks to my portfolio will lead me to my financial freedom and get out of the rat race.

To Summarize
After reading this article content, I hope you readers understand the term of value investing. It’s pretty simple and straightforward to comprehend. Many successful investors have used value investing method to make huge fortune. It’s safe for investors who seek safety for their stock picks. Applying value investing strategy, you as an investor understand the fundamental and value for each share you own as if like owning a small piece of the company. This will make you feel as if you are a small part owner of the company. You don’t need to worry about losing money when applying value investing compared to when you are just speculating. However, you’ll still need to be careful of laying yourself in investing in a stock that is a value trap. Moreover, you will see share price decline more as an opportunity to purchase more shares since you comprehend business model well. If you want to become a better value investor, you just need to put more time in learning to become one. If you are keen to learn more about it, you can simply browse the contents I have provided in this finance blog
. I hope the articles that I posted in this finance blog provide lots of quality contents that give you readers an idea to become a better value investor. I hope you readers see this article helpful as well as motivating to become a successful value investor.

No comments:

Post a Comment