Investments 101: What is Value Investing?
A few weeks ago, we had a live class about creating and managing investment portfolios in uncertain times.
During the class we discussed how our investment portfolios are influenced by our future needs and the vision we have for our lives.
We also spoke about this concept of generational wealth and wealth creation - wealth that outlasts our lifetime, so even our children don't have to worry about retirement.
There are many ways to do this.
Investing is one way but within the financial world, there are many schools of thoughts on how to get the best return on investment.
The school of thought I like is: Value Investing.
This is the school of thought that Warren Buffett subscribes to.
What makes you a value investor?
1. buy undervalued stock
When you follow this style of investing, you invest in company stocks or equity (shares) that are undervalued on the market.
The mentality here is that you make your money when you buy a stock and not when you sell.
You want to invest in companies that still have room to grow and that will continue to be profitable in the future.
For example you buy a stock for US$20 on the stock market, only because you're sure it's worth US$40.
How do you know the true value of the share?
The value of anything is subjective, but you do your research. You research the industry, research all the companies operating in that industry, the company's management team and the company's financial statements.
But...this is where value investors clash with Wall Street.
Wall Street brokers look at the numbers and the financial history of the company and then they make the decision to buy a company.
Value Investors like Warren Buffett use a lot of Emotional Intelligence when investing - they look at the numbers, but they also look at the character of the managers and the board of directors that run the company.
They believe that a company can only grow if management is trustworthy and a company that’s run on sound values by leaders with a clear vision and strategy.
2. Value investors look at investing as a long term game
They believe in buying a stock forever, not even for 5 or 20 years but forever and that's why they need to understand the company's vision and leadership.
They don't sell during bad economic times. They only sell when the share becomes overvalued.
So imagine your $20 share skyrockets to $60. But you know it's only worth $40 on a good day. That's a good time to sell.
Your investment decisions aren't dictated by the market's mood swings but by deductive logic.
In general, when times are bad, people freak out and start selling their investments.
If you're a value investor, bad news on how the market is doing doesn’t impact you and neither does good news.
3. Research, research and understand what you invest in
Value investors like Warren Buffett, spend months researching a company and industry before making an investment decision.
When the Internet bubble happened and everyone was investing in every dot com company because it was new and hot, Warren Buffett wasn't interested - he invested in Coca Cola and Unilever and said they were entering the new millennium with these products because he couldn't understand the business model.
(I have been reading Warren Buffett's newsletters since I decided to study finance and economics at 18).
Everyone said he'd lost his touch but when the bubble burst, those people lost their money.
He waited for the bubble to burst and then invested in Amazon and IBM, because their business models were simple and easy to understand.
Value investors, invest in things they understand and that make sense to them.
They believe in simple and easy to understand business models.
4. focus on companies that are more concerned with profitability than share price
We live in a world where managers are rewarded, not for being profitable, but for increasing the share price.
Value investors, understand that share prices are influenced by PR and that depends on how the public feels about you at any point in time.
Companies grow through profitability and of course PR also influences profitability but a company that focuses on profits and company growth, already understands this so they’ll manage PR but also focus on building a good business to support that PR.
Basically, they want to invest in companies with a good foundation - financially and ethically.
Again - research is the key word here and as you can see, it's not just about the numbers.
5. Ethics
Value investors understand that companies that are built on bad ethical practices are PR disasters because eventually the truth comes to light.
And when that happens companies lose money, investors jump ship and shares lose money, which means you lose money as an investor.
So they do their research on how the company conducts business and if this will be a problem for them later.
They’re obsessed with investing in companies that are honest and open with shareholders.
This is very different from trading shares or Forex.
Value investors aren’t thinking just about making money from market movements or even from an increase in the next few years; they're thinking about long term growth.
Personally I see myself moving into this style of investing when I start investing in individual shares on the stock market (currently I invest in EFTs instead of just individual shares).
I just don't have the time to do this in depth research so I choose passive investing.
I leave you with a quote by Warren Buffett, "Rule number 1; Don't lose money. Rule number 2: Never forget rule number 1."
Let me know your thoughts in the comments section below.
