You may have heard of famous investors such as Warren Buffet and Benjamin Graham. Do you, however, know about the investment strategy that allowed them to reach the summit of the investing world? In this article, we will be exploring the strategy of Value Stocks and Investments. We will explore the philosophy and mechanisms behind this strategy and then examine their implications within the broader investment world.
Definition of Value Stocks
If you’re up to speed with developments in the T.V sector, you may anticipate when a TV is about to go on sale. This would eventually allow you to buy the same product at a lower price. The Value Stock investment strategy essentially follows the same principle; in this case, investors put their money into stocks which they perceive as undervalued.
This means that the market-determined value of the stock is much lower than the fundamental worth of the industry within which the shares are held. In turn, this means that investing in such a stock would reap long-term rewards.
Since investors following this strategy see this stock is undervalued, they bet on its appreciation, outpacing the competitors of the value stock as well. To accomplish this, they evaluate that the over-reactions of the market cannot determine the intrinsic worth, and worth must be analyzed in other ways. Since the market is undervalued or overvalued, it is possible to determine how to create a long-term strategy with value stocks through such analysis.
Such analysis is made by comparing the prices of the stocks with the revenues, earnings, and dividends of the industry in general. In the stock market world, the discount is represented by the undervalued stock, which can be sold for a profit later on.
Characteristics of Value Stocks
There are several ways to spot a value stock, and we will discuss those in this section of the article. Put plainly, a value stock firstly has a Price-to-Book (P/B) and a Price-To-Earning (P/E) ratio, which is lower than the general market. This means that the asset value and the stock’s earnings are undervalued relative to the prices of the product and the general prices in the market.
Secondly, they grow their earnings and revenues at a slower rate than the general market. And lastly, they are seen as less-risky stocks which have arisen from well-established companies with a history of professional financial performances.
Such characteristics make a stock highly likely to be a value stock that an investor can utilize for long-term gains. This makes value stocks somewhat protected from risks. For private wealth companies such as RVW Wealth which prioritize investor security, such stocks are essential to long-term security.
Characteristics of Value Investors
Several characteristics show that an investor follows the philosophy of the value stock strategy. Again, investors who follow this line of thinking generally disagree with the efficient market hypothesis, are contrarians and keep a margin of safety. These three characteristics align perfectly with the characteristics of a value stock.
First and foremost, they show that these investors are concerned mainly with the intrinsic or true worth of the stock. To evaluate this true worth, they do not rely on market forces which they believe are susceptible to the influences of short-term trends and fads. Instead, they emphasize the need to compare the stock’s price to the perceived true value of the stock as determined by their revenues, finances, branding, history, and general sales and earnings.
Asides from this, investors also keep a Margin of Safety. This complex-sounding term has a simple meaning: they invest while prioritizing risk management and maximizing long-term gain. Lastly, they are contrarians. You won’t see a value investor going with trends, selling in a frenzy, or buying up shares of the latest social media-driven fads. They tend to keep away from such short-lived growth stocks and focus more on stocks with long-term sustainability.
Why do Stocks become undervalued?
Now that we have identified that value investors do not put great emphasis on market efficiency, you may ask: then how do they identify that a stock is undervalued? After all, you may be wondering about the value investor’s mechanisms to create their judgments and assumptions. So in this section of the article, we will be discussing why stocks may become undervalued:
Herd Mentality and Market Forces
Investing without understanding fundamental market forces and the stock you have invested in can lead to irrational decisions. Such a common occurrence leads amateur investors into what is known as a herd mentality. If the stock is going up, the investor will make an irrational investment without understanding the reasons behind the increase in price.
The only major driving force is psychological insecurity to not be left out. The same goes for when a stock is going down since investors will sell off their stocks to minimize their perceived loss. The latter occurrence can exacerbate the initial decrease in value by causing an enormous increase in-stock supply.
This would then decrease prices much more than the initial market moves, consequently undervaluing the stock compared to its intrinsic value at the time.
Unnoticed Stocks and Bad News
Social media news regarding stocks may not be the best place to make investment decisions, at least according to value investors. This is because the news focuses a lot more on glamorous and short-lived technological developments and fads, which sideline more stable stocks within consumer industries.
These could include the healthcare industry stocks or others from the automobile industry. Such stocks do not usually get the same level of press as technological trends and are usually ignored by investors who wouldn’t be inclined to invest money into important industries.
In addition to this, a very negative press regarding a historically stable enterprise can also lead to exaggerations in stock values. For instance, if there is litigation or accusations of mismanagement at the business level, immediate panic can lead to selling stocks. This would lead to the undervaluing of these stocks, especially if the industry in question was stable.
Market Crashes and Cyclicality
Market crashes are often an exacerbation of cyclical business recessions and can become a consequence of these recessions. Since every economy goes through periods of recessions and downturns, there may inevitably be a dip in stock value for a certain period.
However, this dip can lead to panic selling, leading to an exaggerated decrease in market value. The economic cycle does not usually reflect a change in the structure or supply of the industry.
This, in turn, means that there isn’t a particular link that shows that a recession would necessarily lead to a decrease in the intrinsic value of a particular industry. Market crashes are somewhat similar but quite rare and more specialized. Examples of crashes include the Dot Com crash of the 2000s during the Internet Bubble and the housing market crash of 2008.
These crashes usually happen when recent developments or economic innovations lead to such an enormous increase in stock values that it creates a bubble. When investors realize that they’ve been caught in this bubble, they will panic and try to get out of it as quickly as possible.
Unfortunately, the common shareholder holds the same mindset, which will create a herd mentality. When the bubble bursts, the stock value will plummet below the stock’s intrinsic value in the first place. The phenomenon here is that the companies plummet below their market value due to becoming over-valued in the first place.
Benefits of Value Investing
Now, we have seen the different characteristics of value stocks and how they can be spotted. What’s left is to see the actual benefits that may arise from using the Value Investing strategy in the stock market. So, in this section of the article, we will be discussing these benefits:
Less Risk and Low Volatility
As a value investor who focuses on value stocks, you won’t be prone to decisions grounded in irrationality and emotional outbursts. Since your investment is long-term, you won’t be caught in a herd mentality that buys and sells stocks in accordance with the movements of the market. In fact, it will do the exact opposite and ensure that you don’t even have to focus on these trends.
This is because value investing does not believe in the efficient market hypothesis, and investors will hence not need to worry about the volatile market. There will also be risk aversion since the investor will not need to concern themselves with day-to-day movements of the market, which are the biggest contributors to investor loss.
Best Path to Stock Market Profits
Firstly, and very importantly, with value investing, you won’t have to pay earnings on short-term stock holdings. These transaction fees can be very high and can decrease profits as well. However, the most important benefit of value investing in relation to the stock market profits is that the investors choose stocks that are less in value than their intrinsic worth.
This means that the stocks are backed by financially powerful companies and can therefore generate high earnings in the future. It allows you to take advantage of an inexpensive stock and profit off of it through a thorough analysis of the fundamental blocks of the stock (its revenues, dividends, cash flows etc.). Such a strategy is a brilliant way to make high returns while minimizing risk by investing in undervalued stocks.
In summary, we have discussed what a value stock is, its characteristics, and its various implications and benefits. We can see clearly that such investment strategies relating to value stocks can yield quite hefty rewards.
Obviously, the examination of what constitutes a value stock requires a thorough and detailed examination and study of the industry and its earnings. This makes the investment strategy one which is long-term and sustainable but also in need of hard work and finance knowledge.
However, for firms such as RVW Wealth which prioritize customer security and personalized risk management, such stocks can and should be included in diversified portfolios. Doing so will likely produce excess returns over the long run.
September 08, 2021