What is Value Investing – Your 5-minute Guide to a Profitable Investment Strategy
Buy low and sell high – that is the most common mantra of success in the world of investing. To achieve this golden result, investors try many different strategies in the different investments that they pursue. One of the most popular strategies is value investing. Even some legendary investors attribute their success in investing to value investing strategy.
What then is the secret of this investment strategy? How can you use this strategy to invest your way to profits and prosperity? These and similar questions must be on top of your mind right now. If that is the case, then do not worry. Help is at hand – in this article, we will quickly and comprehensively explain this investment methodology.
How Does Value Investing Work?
As the name suggests, value investing is all about searching for instruments (investment opportunities) that offer value. In other words, value investors in any market would typically search for cheap (or, more precisely, undervalued) investment opportunities. They would invest in such opportunities (typically, purchase such assets) and wait for the price to rise. Generally, such investors have a relatively long investment horizon.
Consider an investor who is interested in the equity market and applies value investing principles in this market. Such an investor would often search for old, well-established companies in mature industries. Shares of these companies may not offer very rapid gains (quick gains in value). However, some such shares may be undervalued and thus, may be expected to yield good returns over the long term.
The rationale behind such expectation is quite simple. In the short term, there may be many fluctuations in the stock market. As a result, shares of some good companies may be under-priced (undervalued) for some time. But, over the long term, well-managed companies in stable industries would be expected to perform well and hence, yield good returns. In the long term, it is expected that periodic stock market fluctuations would not have much impact on good companies. Value investors would try to target under-priced shares of such companies.
Value investors typically have a long investment horizon. As we have seen, they believe that in the short-term, market fluctuations may lead to loss of value (price decline) even in good instruments. They further believe that in the long term such fluctuations would not be significant. In the equity markets, value investors may often have an investment horizon of 10 years or even longer. In many cases, value investors may not even have any intention of selling off the shares that they have purchased. In such cases, value investors believe that the company in which they have invested will keep gaining in value steadily over the years. Hence, selling off the shares would imply giving up potential gain in value in subsequent years.
Many investors also apply value investing strategies in the real estate market. Again, such investors would look for investment opportunities in established cities and towns. Properties in such areas may not gain in value rapidly but may be expected to yield good appreciation over the long term. Hence, investors with a long investment horizon may invest in such properties.
Applications of Value Investing Strategy
We have already seen the basics of how value investing strategy is applied in the equity and real estate markets. Let us now take a deeper look at how different investors apply this strategy.
As we have seen, value investors seek to invest in established companies (in the equity market) and in established towns and cities (in the real estate sector). These are relatively safer investments (low risk investments). Hence, such investments are a good option for investors who are looking to safeguard their capital. Thus, investors looking to protect their capital may invest all of their funds (or a large part of their funds) using this strategy.
Similarly, investors looking for quicker returns on their portfolio in general may choose to invest some portion of their portfolio using value investing strategy. Such investors would typically invest the bulk of their portfolio on riskier investments that are expected to yield higher returns in the short term. Correspondingly, they may invest a portion of their funds in safer investments (less risky investments). The purpose behind this is to ensure that they have a balanced portfolio – a portfolio that has a mix of some high risk, high return investments and some low risk, safer investments.
Investors interested in fixed income investments may also pursue value investing with some or all of their portfolio. The logic behind this is fairly simple. Established companies may often issue regular dividends. Hence, investing in shares of such companies can provide steady income through dividends. Similarly, property in established cities and towns may generate good rental income, which may again provide an additional source of income. Thus, value investing principles may be useful even for those investors who are interested in fixed income from their investments.
Investors who are interested in the equity market need not always invest in shares directly. Instead, they can invest in mutual funds. Such funds are professionally managed and typically invest their funds over a wide variety of shares. Mutual funds offer a lot of flexibility to investors. Some funds invest only in high risk, high return stocks while others invest purely in safer stocks. At the same time, many funds invest in a mix of some high risk, high return stocks and some safer stocks. Some funds invest a part of their portfolio in stocks and the rest in other instruments like bonds, etc. Some funds – called fund of funds – may invest in several different funds (and not in stocks directly).
Due to the flexibility offered by such funds, investors – irrespective of their investment strategy – need not invest in stocks directly. Rather, they may choose to invest in one or more of these funds. Thus, investors interested in value investing may choose to invest in those funds that have similar investment goals. The advantage of investing in such funds is that investors need not analyse each and every company (and its shares) themselves. Instead, fund managers would do this analysis and make appropriate investment decisions.
Similarly, there are many funds which invest in stocks of real estate companies. Instead of investing in individual real estate projects, value investors may choose to invest in funds that target established real estate companies. Again, this saves investors the time and effort needed to analyse individual projects.
You have now gained a comprehensive understanding of value investing. As you have seen, this is a very common strategy and is used by investors with a wide variety of investment goals. Thus, you are now empowered to apply this strategy in your portfolio and invest your way to success and prosperity.