What Is Value Investing?
“If you are an investor, your decision to buy and sell is based on the underlying economics of the stock you own.”
Value investing is how Warren Buffet built his fortune. Mr. Buffet learned from his professor at Columbia University, Benjamin Graham, to whom the above quote can be attributed.
Graham is widely considered to be the father of Security Analysis is the seminal work on value investing. In 1949, Graham followed up with The Intelligent Investor, which quickly became a classic on the subject. In the second book his focus shifted from individual companies to groups of stocks and investor behavior.
Rather than chasing popular names or looking for fast-moving stocks, Graham preferred a more quantifiable, disciplined approach to investing. He preferred to invest based on the “underlying economics” of the stock.
The goal of a value investor is to find companies with strong profitability that are currently priced below the true value of the company. Mr. Graham called this “margin of safety.” The bigger the difference between the market and economic value, the greater the margin of safety.
How Does Value Investing Work?
“Spinoza’s concluding remark applies to Wall Street as well as to philosophy: ‘All things excellent are as difficult as they are rare.”
In order to determine a company’s level of profitability and its true value, investors must analyze annual financial reports that are often several hundred pages long. This part alone is no easy task.
After getting a picture of the company’s financial health, a value investor must then decide on their expectations for the company. Everything from revenue, costs, tax rates, and profit must be forecasted to determine the value of the company at present.
This work takes time and ample amounts of research, and can scare off less disciplined investors. Maybe this is why so few investors actually follow the entire process to find truly undervalued companies?
Making Value Investing Easy
“Investing is a unique kind of casino — one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor.”
We’re making true value investing accessible at New Constructs, ensuring that you can play by Graham’s rules. We scrutinize every single page of a company’s 10-K so that you don’t have to. True value investors know just how important this analysis is.
Our analysts uncover exactly where a company’s profits are coming from and where money is being spent. It is this level of analysis that gives us unique insight into a company’s valuation and allows us to find undervalued companies unknown to the rest of the market. Our patented technology allows our analysts to perform Graham-style due diligence on over 3000 companies.
Following Graham’s Principles Creates Easy Decisions
“The stock investor is neither right or wrong because others agreed or disagreed with him; he is right because his facts and analysis are right.”
We highlighted Western Digital Corp (WDC) back in December of 2012. At the time, our analysis found that Western Digital’s after-tax cash flows were strong and growing despite the market’s pessimism on the digital storage industry. However, strong cash flows alone do not make a good investment. Digging deeper, we found that WDC’s price of $34/share vastly understated the true economic value of the company. This cheap valuation, when combined with the company’s excellent profitability, made WDC a very attractive investment.
Since our feature in 2012, Western Digital is up 191% overall, or 69% compounded annually. This return greatly outpaces the S&P 500’s returns (42% overall, 20% compounded annually) over the same period.
When performed correctly, value investing is the best way to make money in the stock market. There is a reason Benjamin Graham’s investing style is still used to this day. It works, plain and simple.
Become a member now and start your path to becoming a value investor using the same principles made famous by Benjamin Graham.
Kyle Guske II contributed to this report.
Disclosure: David Trainer, and Kyle Guske II receive no compensation to write about any specific stock, style, style or theme.