Value Investing
From Financial Literacy Wiki
Value investing works on the principle that the market is inefficient. Value investing is an investment style that dates back to Graham and Dodd and is practised by renowned investors such as Warren Buffet, Peter Lynch and John Templeton. The following assumptions are madee for value investing:
- Investors can over-react to news. Hence stock prices will usually move above fair values, and non-fashionable stocks can be undervalued significantly in the market.
- The use of value screens such as low P/E ratio or P/B ratio is useful in selecting undervalued stocks.
- The use of valuation models to determine fair price
- The belief that given enough time, the stock will reach its fair value.
- Investors must be willing to stay invested over long periods to realise superior returns.
Investors adopting this strategy have to spend a lot of time and effort to search for undervalued stocks especially in a bull market, where all the price of stocks have increased tremendously. Once the undervalued stocks is found, they will make a purchase and hold it till the prices reach fair value then they sell to make a substantial capital gains.
One must take note that the fair value of the stocks should be adjusted with each new information about the companies that come in. This can be a high risk strategy since your capital is focus on specific stocks. To reduce investment risk, one can hold a diversified portfolio of value stocks. As the price of stocks might not reach the fair value within a short period of time, value investor must have the patience capability to hold the stocks.
