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Value investing is a long-term investment strategy that focuses on buying and holding stocks that have the potential to grow or increase in value. These are often referred to as ‘undervalued stocks’, which may be overlooked by current investors or traders.
Some value investors believe that this type of investment strategy can lead to higher returns. Rather than buying and selling stocks within the same day or same week, as it would happen in short-term strategies, value investing focuses on buying and holding the asset for a longer period of time. This article discusses how value investing works and how traders can hold similar long-term positions through derivative products.
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What is value investing?
Value investing involves buying a stock that you think is undervalued and could possibly rise in value in the future, and holding it for a long period of time. This gives the company a chance to grow, manage its cash flow and provide promising balance sheets for the future, which are all aspects of fundamental analysis.
Share prices often fluctuate after a news report or balance sheet is released, which can affect market sentiment for a particular company. Whereas short-term traders focus on these movements and aim to profit from small price discrepancies, value investors focus on longer-term trends and company fundamentals. They ignore most aspects of technical analysis and instead pick stocks based on quality and potential for the future.
Value investors tend to wait until a share’s price is below its intrinsic value before buying. This is essentially to get it at ‘discount’ price.
Value investing returns
Value investors believe that returns from undervalued stocks will greatly outweigh returns from a growth stock, for example, or a company that is considered to be trading above its intrinsic value, and therefore considered to be overvalued in the share market.
One way to evaluate potential returns for value investing is to use the price-book (P/B) ratio. This is a financial ratio that compares a company’s market value (total value of outstanding shares) to its book value (net value of assets). It is also known to some as the price-equity ratio. The formula is as follows:
P/B ratio = market price per share / book value per share
The P/B ratio can help value investors to spot potential investment opportunities. Typically, a lower ratio means that the stock is undervalued, and therefore a good choice for these types of investors. However, this ratio can vary by industry and it is difficult to tell whether the stock is simply undervalued or there are other issues with the company’s fundamentals, such as cash flows and dividends.
Is value investing still relevant?
Value investing rose to prominence during the 20th century with investors like Benjamin Graham and Warren Buffet. We will discuss these investors and their independent strategies further on.
But some investors ask themselves: does value investing still work? Or is it better to take shorter-term positions on the same shares, in order to avoid stock market crashes and potential losses? This brings about the debate of value investing vs trading stocks in the long-term, which can work differently for each individual investor, depending on their overall goals and amount of capital that they are willing to risk.
How to value invest
- Look for a particular type of stock. Some value investors prefer to go for blue-chip stocks, due to their reputation and overall stability within the stock market. This is in comparison with penny stocks, which can collapse at any point of their journey, and growth stocks, which can amount to large profits in the short-term but then start to decline after reaching a growth peak. Industries are also important. Pharmaceuticals and finance are examples of industries that appear to have been more consistently stable than trending sectors over a period of years, in comparison with oil and gas and renewable energy, for example.
- Do research on your chosen stock. Investors can analyse company fundamentals that will have a long-term effect on share price, such as growth prospects, systematic risk and long-term financial plans. Other important things to consider when investing in shares include current dividend payouts, earnings reports and takeover bids, which are all part of company analysis.
- Aim for slow but steady returns. Rather than looking for stocks that provide quick returns but can be volatile within the market, value investors look for a safer option that provides steadier returns. You can use financial calculations such as PEG and P/E ratios to spot investments that seem to be of a lower risk and less likely to be overvalued, especially for comparison with other companies within the same sector.
- Diversify your trading portfolio. Famous value investors such as Warren Buffet and Benjamin Graham have recommended that investors should have a diverse portfolio that include stocks and bonds, for example. Although value stocks have generally proven to provide steady returns in the long-term, this is not guaranteed. Some shares are still high risk, and therefore, it may be wise to include bonds and index funds in your portfolio.
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Famous value investors
Benjamin Graham
Benjamin Graham is known as the ‘father of value investing’ and first developed the strategy throughout the 1920s, detailing it in his books. He theorised that a buy-and-hold strategy would provide safe and steady returns, but only if investors perform in-depth analysis of the company beforehand. This is known as ‘intelligent investing’. Graham was a mentor to Warren Buffet throughout business school and subsequently had an impact on Buffet’s own strategies for years to come.
Warren Buffet
Warren Buffet is one of the most famous stock market investors of all-time. His conglomerate holding company, Berkshire Hathaway, holds interest in a number of blue-chip shares that have provided consistent dividends and growth prospects over the years, including American Express, Coca-Cola and Verizon. On average, the company sees a return of more than 20% per annum, which has remained consistent since it began trading in 1965. Buffet also owns companies such as GEICO, Duracell and Dairy Queen, which have become staples within their respective industries.
Trading vs value investing
The main difference between trading and value investing is the time period involved. Value investing is a long-term method that requires you to pay the full value of the share upfront, which you will then own in the long run. Trading allows you to speculate on the price movements of the underlying share, which only requires you to place a fraction of the value, known as a deposit.
Buying some of the shares mentioned in this article outright could set a trader back by thousands of dollars, and in some cases, the price may not be feasible. For example, Berkshire Hathaway stock currently trades for over $300,000, meaning that many investors will pass on the opportunity.
An alternative way of investing in the long-term is to trade with derivatives, such as spread bets or CFDs, which requires leverage. This gives you better exposure to the share market without having to take ownership of the asset, and also allows you to trade both sides of the market. You can either open a buy position (going long) or a sell position (going short), depending on whether you think that the share price will rise or fall. Although this may seem to be an easy alternative, there are many risks involved. Read more about trading with leverage.
Trading on stocks long-term
Long-term trading in the stock market is a popular alternative to value investing, and it can also help to diversify your overall portfolio as you can trade more than one financial market at a time. Follow the below steps to get started.
- Register for an account.
- Choose your product between spread betting and CFDs. In particular, spread betting is a tax-free* method of trading in the UK, so read about how to spread bet shares for more information.
- Choose the stock that you want to trade. Assess its long-term potential through fundamental analysis, using the tips mentioned earlier. Our market sentiment tool also shows the percentage of traders going long or short on a particular stock, which is a good indicator of market sentiment.
- Pick a trading strategy that is suitable in the long-term, such as position trading. Whereas buy and hold investors can only take long positions, position traders can take long or short. Learn about the differences between trading and investing, relating to tax, duration and strategy.
- Keep up to date with stock market news. After registering for an account, you will have access to our exclusive Morningstar equity reports and Reuters news releases, which may help you to make trading decisions. We also have a dedicated news and analysis section that comes with daily reports on the share market from our market analysts.
We offer over 8,000 stocks on our Next Generation trading platform, along with over 1,000 ETFs. Some mutual funds and exchange-traded funds focus on value stocks in particular and provide access to a collection of underlying shares, which can help to diversify your portfolio. You can browse the Product Library for popular value ETFs from iShares, Invesco and Vangaurd, among others, as shown below.
FAQ
What is value investing?
Value investing is a long-term investment strategy that involves buying and holding a particular stock that is considered undervalued in the market, with the hope of making potential profits. Learn more about how to find undervalued stocks.
Is Warren Buffet a value investor?
Warren Buffet is one of the most well-known value investors. His multinational holding company, Berkshire Hathaway, holds interest in a number of well-known blue-chip shares that he expects to continue to grow in the long-term, including Apple, Bank of America and Visa. See our Berkshire Hathaway live price chart.
How do you know if a stock is undervalued?
An undervalued stock is usually trading at a price that is considered to be of lesser value than it should be. This is in comparison to its growth prospects and average returns for the shareholder, as well as other fundamental analysis factors.
What is a value investing strategy?
A value investing strategy involves buying stocks that are considered undervalued in the share market and trading for less than their intrinsic value. Read more about different types of trading strategies.
How do you know if a company is worth investing in?
To know if a company is worth the investment, traders often perform company analysis to assess its health. This involves analysing earnings reports, price-earnings ratios and potential risks. Traders can then make a decision on whether to invest in its stock.
*Tax treatment depends on individual circ*mstances and can change or may differ in a jurisdiction other than the UK.
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