What is Value Investing?

Value investing is the act of buying stocks which trade at a significant discount to their inherent value. Value investors seek out companies with cheap valuations, usually low multiples of their profits or assets, for reasons which do not seem justified over the longer term. This approach requires a contrarian approach, patience and a long-term investment strategy. Despite risks involved value investing when successful has a consistent history of outperforming returns across multiple equity markets.

There are many reasons why a stock might trade at a discount to its intrinsic value, but the most common reason is short term profit under-performance. This can result in a sizeable share price fall. This can also lead to a strong negative reaction from shareholders who sell their stock fearing further declines in the stock’s value. Value investors however understand that most investments are long term in nature and short-term falls do not necessarily impact on a business’ long term performance. They also recognise that, in general, over the longer term, significant falls in profit are often reversed in businesses with sound fundamentals.

Another reason why a stock could be sold at a discount is due to a major downturn in the overall market, i.e. in March 2020 even the companies with very strong fundamentals were down 20-30% because of massive selling due to fears of the impact of Covid. Value investors look to capitalise on the irrational behaviour and fears of emotional investors. Fear and greed often lead to poor investment decisions based on emotional responses rather than actual reality. Periodically these miss-pricings can become extreme, for example, the bursting of the tech bubble in the 90s, however, they persist to some degree in most markets. This creates an opportunity for long-term value investors. Though this concept may seem appealing, being successful as a value investor can be much harder to do than to say.

Value investing generally does not deliver over shorter time periods and the periods of under-achievement may last for some years during which time value investors need patience and trust in their decisions. They also need to keep a close eye on the company for potential changes of situation, i.e. changes in one of the key factors on which their decision to buy this stock was based in the first place, e.g. a major competitor entering the market, newer technology developed in comparison to the company’s old technology, etc. Value investing takes nerve as well as skill. However, given that a good company was selected while it was at a discount, the long-term results from this approach can be extremely rewarding.

As always though, there are risks in all investments and professional financial advice should be sought before making the leap into value investing.