What Is Value Investing? A Beginner’s Guide

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Value investing is a strategy based on buying undervalued investments and holding on to them for an extended period of time. Learn about the principles of value investing.

 

A value investing strategy is based on buying undervalued investments and holding on to them for an extended period of time. Generally, value investors focus on strong companies with a long history of solid returns, and aim to purchase those stocks when they appear to be underpriced.

Though value investing takes time and patience, it’s a popular strategy among many well-known investors. Warren Buffett, for instance, considers himself to be a value investor. “Never count on making a good sale,” Buffett has stated. “Have the purchase price be so attractive that even a mediocre sale gives good results.”

That sentiment is shared by many value investors, who intend for their stocks to trend positively over the long-term, rather than trying to time the market or pick a growth stock that may (or may not) experience meteoric short-term growth.

 

How does value investing work?

In theory, value investors buy stocks with a significant delta between the current price and the stock’s intrinsic value. Over time, and as other investors notice this delta and purchase the stock, the price corrects. In turn, the investors’ portfolios gain value.

 

Value investing is a slower process, though. If investors can’t hold out long enough for that investment to correct—or that expected correction never comes at all—they may still find themselves losing money. All stocks are unpredictable, and there are no guarantees when it comes to investing.

 

5 value investing principles

There are five general principles of value investing: 

 

  1. The price is right. When it comes to choosing value investments, investors are looking for stocks that are underpriced compared to the company’s intrinsic value, and are likely to gain value over time.
  2. The companies are established. Seasoned value investors look for reliable companies with a history of steady growth, a solid financial structure, and a strong management team. Although none of that guarantees future growth, companies that have shown progress for years (or even decades) may be more likely to continue on an upward trajectory. 
  3. Dividends are (usually) offered. Value investing typically involves seeking out companies that consistently pay dividends, as dividends are generally associated with more mature and established companies. (Newer companies tend to reinvest in their business.) By paying dividends to investors, these companies indicate that they are moving out of the initial growth phase and feel financially stable.
  4. Growth is slow but steady. By definition, value investing stocks are most likely to provide consistent growth in the years to come, but they generally won’t involve explosive growth. Value investing instead focuses on buying stable investments at a good price, then holding onto them as they steadily (albeit, slowly) grow. 
  5. Diversification still matters. Regardless of the investments purchased, value investors still recognize the importance of portfolio diversification as a way to amplify growth and hedge against loss.

Growth vs. value investing

The value investment strategy is different from a growth investing approach.

With growth investing, investors try to find and purchase stocks that they expect to have explosive short-term growth. (Think stocks like Amazon or Tesla, which have seen unprecedented success in recent decades.) These are generally newer companies; although their assets and financial history don’t necessarily support their stock price, and may even seem overvalued, these investors believe the potential for growth warrants the risk.

 

Here are the key points of difference between value and growth investing. 

  • Typical stock price. Value investing focuses on stocks that are perceived to be reasonably or under priced, whereas growth investing focuses on stocks that may appear overpriced. 

 

  • Expected growth timeline. Value investing takes a long term view, whereas growth investing takes a short term view. 

 

  • Dividends. Value investing usually involves stocks that pay dividends, whereas dividends are uncommon in growth investing. 

 

  • Typical company age. Value investing focuses on older, established companies, whereas growth investing focuses on newer companies.

Some investors will choose value investing vs. growth investing (or vice versa) if it better aligns with their risk tolerance. Other investors may choose to balance their portfolio with a blend of value and growth stocks.

 

Choosing a value stock

To sift through potential value stocks, investors will typically do extensive fundamental research, including the following:

  • Examine the company’s history. Investors want to know: Does the company’s past indicate strong leadership, values, and a history of innovation? 

 

  • Consider the company’s assets and financial stability. Investors often analyze the company’s solvency, financial management, and asset stability. 

 

  • Scrutinize the company’s future plans and projections. Does the company hold patents or specialized technology that competitors don’t? Do they lead the industry in innovation or have other advantages?

 

  • Determine whether dividends are offered. Dividends are not required for a stock to be a value investment. They are frequently offered by mature, financially stable companies, however, which may signal value potential to investors.

  • Analyze the industry. Certain industries are cyclical by nature. Although the stock prices may rise initially, that growth may be lost further into the cycle.

The bottom line

Value investments are a common choice when it comes to promoting stable, long-term portfolio growth and potentially earning dividends along the way. They require patience and time, but remain popular among some of history’s most successful investors.

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