Tag: Risk

Value Investment

Value investment strategy is one of the strategies used in the stock market, where investors look for the companies that have the ability to generate returns at a reasonable level during a sustained holding period. In other words, a value investor tries to find a company that is undervalued by the market, but it has a potential to show an increase in its share value once the market rectifies the error of valuing that firm. So, it allows an investor to buy a well performing share at a cheaper price.

How to Screen for a Value Stock?

Value investors are not concerned with the factors that usually cause price fluctuation in the market. For them, the factors that would impact a stock price are oil prices, inflation reports, wars, and hikes in the Federal rates. This is the reason why they look for stocks with strong dividends, earnings, cash flow, and book value, because value investing is not just about purchasing an undervalued stock, it is about purchasing a good stock that is undervalued. However, just having the strong fundamentals doesn’t necessarily mean it will be a value stock investment opportunity, because a company with strong and consistent earnings growth, attractive cash-flows, decent dividends, and a minimal amount of debt might represent a growth investment, and so, value investors won’t be interested in it.

An investor must keep three questions in mind when he seeks a high value stock:

  • How is the cash-flow position of a company?
  • If the company is generating profit from its key operations?
  • What are the future prospects in terms of growth potential?

Quantitative Aspects

How to assess a good value stock? (Just some RATIOS)

  • High Dividend Yield – The stock with an ability to generate high dividend yield, is considered a good value stock. However, a comparison should be made in the same industry.
  • Low P/E Ratio – It is a comparison between a share price and the earnings generated by each share. Paying less for more profit will be a good indication of a good value stock.
  • Low Price to Book Ratio – The lower this ratio is, the better it would be, as it shows how much will be left after the liquidation.
  • PEG Ratio – Value investing doesn’t simply means investing in low Price to earning stocks. Another largely accepted metric for finding out the intrinsic value of a company is PEG ratio, which is calculated by dividing the P/E ratio of a stock with its projected earnings growth rate over the years. It measures how cheap a stock can be while keeping in mind the growth of its earnings. Therefore, a PEG ratio of less than 1 means a company is undervalued.
  • Net-Net Method – According to this method, if a company trades at 67 percent of its current assets, an investor doesn’t have to adopt any other measure of worth, because it depicts that a buyer is getting all the non-current and intangible assets free of cost. But, there are only a few companies that are trading this low.

Qualitative Aspects

Value stocks can be found in any industry, including finance, energy, and even TECHNOLOGY. Yet, they are mostly commonly located in industries that have recently been hit by a difficult time, for example, the cyclical nature of auto industry give rise to a period of undervaluation of companies like General Motors and Ford.

Warren Buffett, one of the most astute investors of all time, learned the art of trading from Benjamin Graham, who was the father of value investing. Buffett has always emphasized that buying a good company at a fair price is far better than buying a fair company at a good price, which is true. Value investing is not about purchasing stocks at a bargain price and hoping for the best, nor is it about making quick money on a market trend. The main idea behind it is to invest in companies with strong business models.

It is important to have a long term strategy with value investing. The investors shouldn’t get faltered by short term market features, such as volatility or daily price fluctuations, because a good firm will not lose its worth even on a bad day. Although, value investment strategy is dependent on a stern screening process, yet, it has a potential to generate reasonable returns in the long run.

Basic Investment Strategies

Deciding on a suitable strategy to fuel your investment plan is based on various factors, including the risk appetite, the time span of an investment, and financial goals. Some investors stick to one particular strategy, while others use several strategies over a period of time. Although, investors usually have their own style that forms the basis of their decisions, yet, there are some basic investment strategies that can be employed to achieve your financial objectives.

Define Your Goals – Defining a goal is the first thing every investor should do. You cannot go about investing in the market haphazardly without having any plan in mind, or else you would end up losing all your money. Always devise a sound trading plan and define your financial goals. It allows you to identify which financial instrument is most suitable for you and enables you to take timely decisions.

Diversify – Investing is a broad term that can be intimidating for newbies as it involves a wide variety of investment vehicles and hundreds of strategies. However, it can be managed if you devise a flexible and effective plan. Today, investors have more investment options than were available to an average investor ten years ago. Having a few stocks in your portfolio might cost you more in the beginning, but it will be beneficial in the long run, because one of your investments might only generate 5 percent profit, while the other one gives you a 100 percent return five years later.

Monitor Your Investments – Investing in the same stock forever is never a wise option. Even the blue chip companies can turn out to be a failure, because the old perception of buying and holding the stock forever doesn’t work in today’s world with such an effervescent economy. Therefore, monitor your investments and take timely decisions to avoid losses.

Start Investing Early – The sooner you start, the better. This is certainly true when it comes to investing in the financial market. If you keep your money invested for a longer period of time, it will have more potential to grow. Patience is the key! If only you learn to practice patience and adhere to a long term investing strategy, you would definitely experience financial success and secure reasonable returns.

Turn Discretionary Income into Your Investment – It is important for you to not confuse your needs with wants. The president of the U.S. Retirement Strategy for Transamerica Retirement Solutions, Stig Nybo, once said that phone bills, cable TV packages, and other automatic services eventually become necessities, which doesn’t let the would-be investor jump out of it. He further said that you should question the things that have become the norm, but they might not be necessities.

Adhere to a Cash-flow Plan – It is an essential element that should become a part of your investment plan. Reinvest your money every month during your employment years and stick to a strict cash-flow plan, while making reevaluations as life progresses. This will definitely help you go a long way and enable you to achieve your financial goals.

Separate Emotions from Financial Decisions – Emotions play a major role in your investment decisions. But, it is very important to separate emotions from your short as well as long term financial objectives. Emotional involvement tampers with your judgment and performance. Just because everyone is talking about hot stocks, doesn’t necessarily mean it is going to be a good investment. Always analyze the trends and pay close attention to market news and events, as it allows you to take rational decisions in the long run.

Assess Your Tolerance for Risk – Whenever you invest in the market, ask yourself one simple question, “How much can I take and sleep at night if the value of my investment drops by 10 percent or 50 percent?” If a huge decline is going to hit you hard, you should consider investing the major portion of your funds in safe investments, such as, bonds or utilities.

However, bear in mind that it takes some time to be able to understand the gist of these strategies. Being a newbie, you might initially experience a high risk of loss if you follow one of these strategies. Therefore, observe patience and perseverance, because you will eventually get there.