When it comes to investing in stock markets for the long term, one of the most popular and effective investing strategies, often opted by seasoned investors is value investing. Value investing essentially involves putting your bets on undervalued stocks that are trading for less than their intrinsic value in the market currently, but are fundamentally strong. The premise is that a fundamentally strong business will eventually pick up pace and give returns worth its value to patient investors. Many successful investors Like Peter Lynch, Warren Buffet and others are strong advocates of value investing and have followed certain principles of value investing to be successful at it. In this article I will discuss what these principles are, and how you can incorporate them in your investment strategy.
Successful value investors invest buy stocks of businesses they believe are fundamentally strong, instead of going for the “trending stocks’. This means they are able to mute the market noise that surrounds stock investing and stay focussed on the business they have faith in. To be a successful value investor, invest in a business which has a strong governance, holds competitive advantage over peers, has shown a consistent financial performance and has more opportunities to grow in the future. So instead of having a short term perspective and buying stocks based on recommendations and current trend, go for a fundamentally strong business, research well about the company and then remain invested for your investments to yield results.
It is extremely important to understand the business you are getting into. You may have shortlisted a few companies that are fundamentally sound, however, if you still lack clarity on what the business actually is, you wouldn’t be able to predict its future growth potential and hence your investing would be on shaky grounds. This also comes with a slight degree of risk. So while shortlisting companies, make sure you know everything about the business. A good strategy would be to go for sectors you are passionate about. Say technology, then you would be driven enough to research all about the company and understand the inherent nature of the sector.
The next step is to start evaluating the target stock across different metrics that will generate reliable results. There are several tools present in the market to evaluate stocks. Some of them are P/E ratio, PEG ratio, P/S ratio, free cash flow. Apart from this, also evaluate the management quality of the company, their corporate governance practices, any compliance issues the company has run into, debt levels etc.
A successful value investor is able to discern a value bet from a value trap. This essentially means you dig deeper into the real reasons that have led to the stock being cheap. There have been many cases in the past when even the most seasoned investors fell for the value traps. For example, consider a pharmaceutical company that has a drug patent to its name and is selling quite low. The P/E ratio is quite high and seems to be an extremely good proposition. This may seem quite a deal but there are equal chances that rather than a value deal it is a value trap as the patent in its name might be expiring soon. Once the patent expires, the revenues will fall down, P/E will fall down and this may affect your return. So pay heed to the real reasons
The secret to value investing is patience and diligence. Diligence in putting in the effort to research and analyse companies and patience to stick with your investments despite the market noise. So analyse a business from all angles, have foresight and then allow your investments to reap results.
The author is Co-founder, and COO, Groww