Value+Investing

Unlike some investment strategies, value investing is pretty simple. It doesn't require that you have an extensive background in finance (although understanding the basics will definitely help), sign up for an expensive subscription service or understand how to analyze squiggly lines on charts. If you have common sense, patience, money to invest and the willingness to do some reading and accounting, you can become a value investor. Here are five fundamental concepts you'll need to understand before getting started.

The basic concept behind value investing is so simple that you might already do it on a regular basis. The idea is that if you know the true value of something you can save a lot of money if you only buy things when they're on sale.
 * Value Investing Fundamental No. 1: Companies Have Intrinsic Value**

Most folks would agree that whether you buy a new TV when it's on sale or when it's at full price, you're getting the same TV with the same screen size and the same picture quality. The obvious assumption that we have to make is that the value of the TV will not depreciate with time as new technology becomes available. Stocks are the same way: the company's stock price can change even when the company's intrinsic value is the same. Stocks, like TVs, go through periods of higher and lower demand. These fluctuations change prices, but they don't change what you're getting.

Buying stocks at bargain prices gives you a better chance at earning a profit later when you sell them. It also makes you less likely to lose money if the stock doesn't perform as you hope. This principle, called the margin of safety is one of the keys to successful value investing. Unlike speculative stocks whose price can plummet, it is less probable that value stocks will continue to experience price declines.
 * Value Investing Fundamental No. 2: Always Have a Margin of Safety**

You might already apply this principle when you shop. When you buy new clothes, maybe you don't like to pay full price because sometimes an article of clothing just doesn't work out. It might look good and feel comfortable in the store, but then when you wear it in real life, it feels too tight or too loose or it fades or shrinks in the washing machine. If you buy a shirt on sale for $20 instead of buying it at full price for $60, you will only lose $20 on a bad shirt purchase. If you pay $60, your loss will be significantly greater. By purchasing the shirt on sale for $20, you limit your potential loss. On the other hand, you might end up wearing the shirt a hundred times, making it a great bargain at only $20. Either way, you're better off buying the shirt for $20 than for $60. Of course, unlike stocks, your clothes won't appreciate in value and you won't sell them for a profit later.

Value investors implement the same sort of reasoning. If a stock is worth $100 and you buy it for $66, you'll make a profit of $34 simply by waiting for the stock's price to rise to the $100 it's really worth. On top of that, the company might grow and become more valuable, giving you a chance to make even more money. If the stock's price rises to $110, you'll make $44 since you bought the stock on sale. If you had purchased it at its full price of $100, you would only make a $10 profit. Benjamin Graham, the father of value investing, only bought stocks when they were priced at two-thirds or less of their intrinsic value. This was the margin of safety that he felt was necessary to earn the best returns while minimizing investment downside.

Value investors don't believe in the efficient-market hypothesis which says that stock prices already take all information about a company into account. Value investors believe that sometimes stocks are underpriced or overpriced. For example, a stock might be underpriced because the economy is performing poorly and investors are panicking and selling all their stocks (think Great Recession). Or it might be overpriced because investors have gotten overly excited about a new technology that hasn't proven itself yet (think dot-com bubble).
 * Value Investing Fundamental No. 3: The Efficient-Market Hypothesis Is Wrong**

Value investors possess many characteristics of contrarians they don't follow the herd. Not only do they reject the efficient-market hypothesis, but when everyone else is buying, they're often selling or standing back. When everyone else is selling, they're buying or holding. Value investors don't buy the most popular stocks of the day (because they're typically overpriced), but they are willing to invest in companies that aren't household names if the financials check out. They also take a second look at stocks that are household names when those stocks' prices have plummeted. Value investors believe companies that offer consumers valuable products and services can recover from setbacks if their fundamentals remain strong.
 * Value Investing Fundamental No. 4: Successful Investors Don't Follow the Herd**

Value investors only care about a stock's intrinsic value. They think about buying a stock for what it actually is - a percentage of ownership in a company. They want to own companies that they know have sound principles and sound financials, regardless of what everyone else is saying or doing.

Source: www.investopedia.com