Top 10 Important Factors for Value Investor – Coming Your Way
Benjamin Graham and David Dodd developed the concept of value investment in 1930s. The concept was simple, find companies that have their stocks undervalued at the time and buy the stocks at that bargain price. Since you have already bought the stock at a lower price, you are sure to get a profit when the market corrects its error in valuation and thus the price.
Value investing is thus a tried and tested formula of earning long-term gains with lower risk. Here are top 10 Important Factors for Value Investor that should be kept in mind while investing one’s money.
1. Understand the concept behind value investing
Unlike the day to day value of a company’s stock value that fluctuates with market conditions, the intrinsic value of a company remains constant for a long period of time. This includes the difference of current assets and current liabilities along with other intangibles that are hard to define.
For example, in a sale of commodity, the price of commodity may be reduced from $40 to $30 but the commodity remains exactly the same. In a similar fashion, the stock may be available at a lesser price but its still a stock.
2. Fundamentals of company
Always keep in mind that a good return will be guaranteed only from a company with strong fundamentals like dividends, earnings, book values and cash flow. A company with a good history is likely to recover from low stock prices once the market corrects itself whereas companies that have consistently performed poorly are unlikely to fetch you any profit.
3. Margin of Safety
One of the most important factors for value investors is the margin of safety. Speculative stocks have sharp decline in their prices whereas value stocks are less likely to do so. Since stocks are purchased at a bargained price, less money will be lost even if it doesn’t perform well in the future. Thus your potential loss is limited. The most appropriate way for this is to buy when stocks are valued 2/3rd or less than their actual price.
You should also read our other article in the “Dumb’s Guide” Series-
Dumb’s Guide to Understanding Stocks and Stock Market
Dumb’s Guide to Investing Money in Stock Market
4. Quality of company as Value Investing is about ownership
Since value investments are focused on profit gain by investing in quality companies and not by trading thus they are not affected by market volatilities as they have no effect on them in long run. So owing a company with sound principles and financials is what matters because these are the value investment factors that help them recover from setbacks.
5. Understanding the business you are investing in
Never make value investments in businesses whose working you do not understand. To make an investment that pays off well in future, you need to know the intricacies of the business it does. Only then can you make correct decision about purchasing a value stock at a lower price rather than investing in a bad stock.
6. Reason for drop in prices
Value investment doesn’t mean buying any stock whose price has fallen. Always know the reason behind falling prices before making your move. The reasons may vary from market volatility to the company being debt-ridden. Make sure that the reasons are temporary and the stock prices will rise eventually.
Read more-
Dumb’s Guide to Understand the Balance Sheet
7. The P/E ratio and Debt/Equity ratio
Its defined as the ratio of a company’s share price to its per-share earnings. Thus it gives market value per share. Lower P/E ratios will be preferred by a value investor as it would mean that the value investor is paying less money to buy the stock as compared to the earnings it will obtain.
Companies with debt/equity ratio below 1 are good for value investment as it means that the company is earning from the money obtained from equity as opposed to borrowed money.
8. Return on Equity
ROE is another very important value investment factor as it gives an idea about the earnings or returns a shareholder gets on his investment. The company with a good ROE for last 10 years is sure to have strong historical performance and thus better chances of performing well in future.
9. Beta Value
Beta Value gives the estimate of volatility of a stock. Thus higher the beta, higher will be the risk. A conventional investor will shy away from such stocks but a high beta is a friend of value investor. The value investor is not worried about the day to day fluctuations in market as long as the intrinsic value of company is higher. So, higher beta will mean a better bargain.
10. Time and Patience
Value Investment is an art that requires time and patience. You cannot expect buying a value stock on Monday and good returns on Friday. There is no formula for correct value investment, you need to stick with your investment philosophy for long time and reap excellent benefits in years to come.
