Free Investor Education : What is Value Investing?

Value investing is tricky because the value placed on a business is often subjective. While the information everyone has access to is the same, their valuations can differ greatly. That's because investors have different risk tolerance. A risk averse investor wants to see dividends and cash flow, but a risk taker might be looking for high growth opportunities.

The intrinsic value of a company is entirely subjective. You can look at historical data but that doesn't guarantee a trend for the future. The trick to value investing is to buy something for less than what it is worth even though you don't necessarily know how much it will be worth in the future. That guesswork is what separates great investors from poor ones.

Remember, value investing isn't just about buying undervalued stocks, its about buying good undervalued stocks. But what makes a good stock?

 Here are a few tips.

High Dividend Yield

This is the percentage that the stock pays out relative to its price. The higher the better, but its important to only compare in the same industry.

Low Price to Book Ratio

Used to compare market value to book value. The lower the better, it gives you an idea of how much would be left over if liquidated.

Low Price-to-Earnings Ratio

Compares the price of the share to the earnings each share generates. Paying less for more profit is the name of the game.

What is Value Investing?

 Value investing is a strategy that involves buying companies that are undervalued in the marketplace. These companies are not hidden gems – they are good companies trading at a lower price than they should be. When we say value, we mean getting a good deal. Its almost like searching for stocks that are on sale.

Value stocks are undervalued compared to their fundamentals. That means that their financials suggest a higher price than what is being charged. This can mean a low price-to-earnings ratio and high dividend yield. The market is not 100% efficient, sometimes there are companies trading for less than they are worth. Finding these stocks is the key to your value investing strategy.

Value Investing Strategy

 At its core, value investing is actually quite simple. Just look for companies that are trading for less than they are actually worth. Seems simple enough, but its actually a bit tougher than it looks. In principal, the value investing strategy relies on finding undervalued companies, buying shares and then making money when the market corrects and these previously undervalued companies go up in price. In this way, the strategy is looking for inefficiencies in the marketplace and taking advantage of what the general market sentiment is.

Warren Buffet is the champion of value investing. He always said that it is better to buy a good company at a fair price, than a fair company at a good price, and he's right. Value investing is not about buying cheap companies and hoping for the best. Its quite the opposite. The value investor isn't just looking to make a quick buck on a market trend, but to invest in companies that have strong underlying business models. If its good enough for one of the greatest investors of our time, it can work for you.

A long-term strategy is essential for value investing. Do not be wavered by short term factors like volatility or daily fluctuation of prices – a good company is a good company even on a bad day. Questions to ask when looking for high value stocks include: How is the cash flow, are they generating profits from their core business operations, and what is the potential for growth?