The core idea of value investing is “Price is what you pay, value is what you get” from Benjamin Franklin. It is the opposite approach to investing in growth stocks based on dreams, hunches and popular opinion.
In his book “Value Investing and Behavioral Finance”, Parag Parikh calls growth stocks “dream stocks” or “fantasy stocks”. Their valuations are based more on illusions of future growth rather than current fundamentals.
For value investors, valuations are about analyzing real sources of value like assets, earnings and reasonable growth estimates. But even this analysis requires discipline, patience and hard work to get right.
There are two types of value – value in use for essentials like water, and value in exchange for things like gold that derive value because others will pay for them. Two distinct concepts help frame intrinsic value – the economic “value in use” concept for essentials like water, and the more subjective “value in exchange” that makes luxuries like gold valuable based on what others are willing to pay. For a business, value in exchange depends on the company’s essential value drivers like assets, earnings, competitive advantages and growth outlook.
It’s not just fundamentals, but the price paid for those fundamentals that determines investment returns. Paying 25 times earnings for a company and expecting 25% growth leaves little margin for error. Earnings could disappoint, or the lofty valuation could deflate, leading to losses on two fronts.
Being disciplined is crucial. Great buying opportunities are infrequent, so you need to stay prepared with cash ready to deploy. Often, investors get caught up chasing hot tips into overvalued stocks, leaving them no dry powder when markets sell off and bargains emerge.
Real discipline means buying when it feels uncomfortable emotionally, and selling when your heart wants to hold but your rational analysis says to exit.
Value investing is about patience, research and buying fundamentally sound companies when they trade below their estimated worth. It’s getting value for your money by not overpaying based on dreams and speculation.
In contrast, disciplined value investors aim to buy outstanding businesses only when their stock price trades at a meaningful discount to a conservative estimate of the company’s intrinsic worth. Determining this intrinsic value is not easy – it requires rigorously analyzing hard assets on the books, ascertaining the true quality of the earnings, and applying prudent assumptions about sustainable future growth.
This sober analysis separates value investing from the emotional speculation so rampant in markets. As Ben Graham espoused, value investing combines the principles of minimizing risk through buying with a “margin of safety”, while maximizing return by patiently waiting for stocks to go “on-sale” periodically.
Value investing requires immense discipline in research, price paid, and controlling one’s emotions. But by diligently buying wonderful businesses at reasonable prices, value investors gradually build outstanding long-term returns by aligning the time value of compounding with the productive genius of great enterprises. It is a fundamentally different and more certain path to investment success than speculating on theoretical narratives and market mood swings.
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