If you are new to value investing and are not sure that you are doing the right thing, this post is for you. It has 3 basic things you need to know about value investing to help you get up to speed.
Be sure to click on the links that appear throughout this article to deepen your understanding.
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Take a quick look at How To Value A Company; The Lazy Investors Guide for a more in depth look at value investing in practice and the type of financial analysis that is important when looking at stocks to buy.
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#1 Benjamin Graham Is The Father Of Value Investing
Benjamin Graham invented it. In other words, he came up with the idea that an investor can value a company and should look to buy its stock below the value at which the company is worth. Benjamin Graham’s’ most famous books are Security Analysis (1934) and The Intelligent Investor. Benjamin Graham wrote The Intelligent Investor for newbies and is the basis for my investing strategy and the one that I share on The Shares and Stock Markets Blog.
#2 Think Of Stocks As Entire Companies, Not Just Numbers On A Screen Or Pieces Of Paper
All too often, investors are faced with the the image of a large bank of screens with flashing blue and red numbers when they think of the stock market. The fact is this: those numbers represent the price of one share of stock for a company.
The price may go up and down on a minute by minute basis but the fact remains that it represents how much the stock market values one share of stock at any moment in time. Consider this: if a stock is priced by the market at £2 a share but following the principles of value investing you conclude that the entire company is worth at least £4 a share, then you understand how to think about value investing: by looking at companies as a whole, valuing them and then buying their stock at a discount to that value.
#3 Ensure That A Margin Of Safety Exists Before You Buy
With the best will in the world, value investors make mistakes. Sometimes the valuation of a company can be wrong, even after careful, thorough analysis. Then there are the gyrations of the stock market to consider – high frequency trading, black boxes, algorithms – the stock market and stock market prices have become very choppy in recent years. These two factors can make you feel sea sick as you watch the value of your investments get thrown around like a rag doll.
A margin of safety – another Benjamin Graham invention. It means that as a value investor, you pledge to buy stocks at a large discount to their value, exactly like our example of buying shares at £2 knowing that they are worth £4. This is why you will sometimes come across a description of value investing along the lines of ‘buying $1 for 50 cents.’ A margin of safety protects you from the markets gyrations and your own error in valuation because you have bought the stock at such a low price in the first instance. Now it’s your turn! Applying these 3 basic concepts to stock market investing will help you sort through the many layers of company valuation. If you’ve tested any of these concepts already or plan to in the future, leave a comment below and let me know.