How value investing works

How value investing works
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Value investing has been a popular investment method for years. Some of the biggest names in finance swear by this investment style.

We’re here to explain everything you need to know about this solid investment strategy. Read on to find out how it works, and more importantly, how you can make it work for you.

What is value investing?

The basic idea behind value investing is to buy stocks and shares when they’re undervalued.

Sometimes, the share price of a company doesn’t truly reflect the value or financial position of that business. When this happens, it can provide a great opportunity to snap up shares at discount prices.

Value investing is a sensible way of putting your money to work, based on some finance fundamentals.

Where did this strategy come from?

The original concept was introduced by Benjamin Graham in the 1930s. You may not have heard of Graham before, but it’s likely you’ll recognise one of his most prominent students, Warren Buffett.

Graham mentored Buffett and taught him all about value investing. Warren Buffett went on to use these skills to become one of the world’s richest people.

Graham’s popular book The Intelligent Investor is still well-read today. It’s an interesting read with a lot of information packed in, but it is slightly dry. Unless of course historical stock analysis is your jam.

How do you know if a company is undervalued?

There are a number of broad things to take into account, such as the company’s brand and business model, their target customers and any unique advantages they have.

Analysing a couple of more measurable key metrics can help determine a company’s value:

  • Price-to-book (P/B ratio): This measures the value of a company’s assets against their share price and can signal undervaluation. A low P/B ratio is usually a good sign for value investors.
  • Price-to-earnings (P/E ratio): This compares a company’s share price to their per-share earnings. A high P/E ratio could mean a company is overvalued.

Further research into things like cash flow can also be important. This is because it might help to determine whether a business can pay dividends, pay off debt or invest in research and development.

Many value investors will also look at a company’s sales and revenue figures, historical growth and debt before deciding whether they think the company is undervalued or overvalued.

Can value investing make you rich?

Definitely. Although, it’s important to remember that value investing is not usually advisable if you’re looking for fast growth. Investors with a shorter timeframe may need to use a different approach.

As value investing is all about buying shares at a cheap price, it’s important that you use a share dealing account with low fees. You should also make sure that the platform you’re using has a wide range of stocks available. Often, under-valued investments aren’t the most popular ones!

Over the long term, this investment style has proven to be extremely profitable. However, it does tend to require research and the ability to read financial statements. Something like index funds may be more appealing for newer investors looking for a diversified portfolio.

Is it risky?

All investing carries a certain level of risk. However, an investment style focusing on value is definitely down towards the lower end of the risk scale.

Because it’s based around sound financial fundamentals, it’s generally considered to be a conservative approach.

Value investing capitalises on the errors of emotional investors who just look at share prices and ignore a company’s actual value.

Does value investing still work today?

A lot has changed in the world since this method was first introduced. Erratic behaviour and emotional investing have not dwindled and so there are still plenty of opportunities to grab shares at bargain prices.

However, technology companies like Microsoft can be difficult to value. This is because their worth doesn’t necessarily rely on tangible assets.

Tech companies make up a big portion of financial markets these days. Calculating their intrinsic value isn’t always as simple as it was for older business models.

So although value investing can still be an excellent method for long-term investors, it can become more complex when it comes to modern companies.

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