3 Best Value Investing Strategy for Stocks (No.3 Makes You Rich)
The world’s most famous value investors earn $26,000 a minute, $1,500,000 an hour, and $37,000,000 a day.
Warren Buffett currently has a net worth of Seventy-one Billion Dollars.
Investing is the first step of building wealth.
Not only Warren Buffett is one of the richest men in the world, but he also revolutionizes investing with his value investing strategy.
What Is Value Investing In Stocks?
Value investing is an investing strategy where investors pick stocks or securities that appear to be selling lower than their calculated intrinsic value or book value.
Contradictory to believers of the efficient market hypothesis (EMH), value investors believe the market overreacts to good and bad news.
This result in stock price movements that do not reflect the company’s long-term fundamentals.
How to calculate the intrinsic value of a stock?
The intrinsic value of a stock is calculated by performing a fundamental analysis of the company.
Calculation of the intrinsic value is done with the company’s financial statement analysis; balance sheet, income statement, and cash flow statement.
3 common methods that value investors used to calculate the intrinsic value of a stock is:
- Discounted cash flow analysis (DCF)
- Analysis of the intrinsic value based on a financial metric
- Asset-based valuation of the stock
Why Does Value Investing Work?
Value investing works because it has a strong focus on the fundamental analysis of a company. Instead of viewing stocks as a bunch of numbers, value investors view each stock as a business.
The dis-polarity between the current market price and the value of the stock provides an opportunity for value investors to buy great companies at a low price.
As the market normalized, the price of the stock will soon reflect the true valuation of the company according to its long-term fundamentals.
Who Are The Famous Value Investors
Famous value investors like Joel Greenblatt, Bill Ackman, Benjamin Graham, and Warren Buffet have built millions by investing in companies that are selling below their intrinsic value.
Warren Buffett is considered to be the most successful value investor in modern history.
By their success, there are a lot of amazing investing books, seminars, courses, and articles written about value investing.
Read Also: Investing Books You Should Be Reading
Different Value Investing Strategy Used By Value Investors
Value investing strategies are generally categorized into 3 different types:
- Buy Low, Sell High-Value Investors
- Passive Income Value Investors
- Long-Term Value Investors
Each type of value investing strategy is different. Different value investors have a different sets of goals in mind, each takes different steps and decisions to become successful investors.
Today, we shall explore the 3 types of value investing strategies that have evolved throughout the decades.
1. The Buy-Low, Sell-High Value Investing
Buy-low, sell-high is the most common value investing strategy. These investors will hunt for undervalued bargain stocks in the hopes of selling them when the stock price becomes fairly valued or overpriced.
Some call these value investors Professional Bargain Hunter.
Buy low, sell high is a simple investing strategy where you buy stocks or securities at a low price and sell them at a higher price.
Warren Buffett named this Cigar Butt strategy.
Benjamin Graham who is the mentor of Warren Buffett used the Cigar Butt strategy in the 1900s.
In the early time of investing, investors will flip through hundreds of pages of a thick book containing balance sheets for different companies to find one that is “cheap” or “on-sale”.
Buy low, sell high-value investors aim to make money by:
- Identifying the cheap stocks to buy.
- Selling the stocks when they think the price is right.
They will continue going through the cycle again and again.
While buy-low, sell-high value investing may be a simple strategy for most investors, it does come with some limitations.
Buy-Low, Sell-High value investing requires the investor to make at least 3 right decisions.
- First, they have to identify a company that is ‘on sale’ at the right price.
- Then, they need to buy the company at the right time.
- Finally, they need to sell the company at a profit.
These sound pretty simple to achieve but when practiced it is much harder.
If you have been buying stock previously, you must have noticed there are some shortcomings of this strategy.
- How do you know the ‘cheap’ company that is ‘on sale’ will not close down tomorrow?
- When do you know the right time to buy the stock?
- How long will you have to wait to sell the company at a profit after transaction fees?
These are just some of the many questions you will have to answer in order to make the right decision.
Such a strategy typically leads to the investor having a limited upside.
Example of Buy low, Sell high
John brought a stock at a price of $1 which he think will in future raise to $2 which he has decided will be the right price to sell.
After 10 months of waiting the stock raised to $2 and he have earn a 100% return over the 10 months period. Undoubtedly an amazing feat.
But for the next 6 months, the stock has risen to $5.
If he have just waited, he would have earned a whopping 500% return over just 16 months.
Having a set price that he thinks is the right price lead to limiting his upside earning potential.
The limit he has placed on himself has limited his returns and potentially earning a 5-bagger or even a 10-bagger.
Is this a good value-investing strategy for you?
Buy-low, sell-high is a good strategy but it requires the value investor to be able to time the market.
Timing the market is almost impossible, not even Warren Buffett can predict how the market will go the next day.
“In the short run, the market is a voting machine but in the long run it is a weighing machine.”
By Warren Buffett
A combination of value investing strategies will be a better idea.
2. The Passive Income Value Investing
Dividend focus value investors with a simple strategy for consistent passive income. Dividend investing is the perfect strategy for investors who wants a layback approach to investing.
This is sometimes called the professional dividend hunter.
Investing in dividend-paying stocks is a great investing strategy for investors looking for stability who will like to enjoy passive income.
This group of value investors would look for undervalued companies that are usually blue chip, or REITs that pay out regular dividends for their shareholders.
Dividend are usually paid on a yearly, quarterly or even monthly basis.
Most dividend investors aim to receive a dividend on a periodic basis.
But there are major downsides to value investors who make their investment decision purely at the dividend payout.
- Not all great companies will pay dividends.
- Not all dividend-paying companies are great companies.
While passive income value investing may be a simple strategy for most investors, it does come with some limitations
Passive income value investing requires the investor to make at least 2 right decisions.
- First, they have to identify a company that is ‘paying dividends’ at an acceptable rate.
- Then, they need to ensure the company will continue to pay the dividend in the long run.
These sound pretty simple to achieve but when practiced it is much harder.
If you have been buying dividend-paying stock previously, you must have noticed there are some questions you may want to answer from this strategy.
- How do you know the ‘dividend paid’ is sustainable for the company’s operation?
- How do you know the high-paying dividend company will not close down its operations tomorrow?
- What if the stock price of the company drops 50% and they pay you a 10% dividend, is it still worth it?
- What if the company you brought can utilize the money better than you and if the money is kept with the company can give you an even higher return?
These are just some of the many questions you will have to answer in order to make the right decision.
Downside of dividend investing as a value investor
If you make your investment decision based on the amount of dividend paid and ignore all other companies that don’t give you a dividend, you may have missed out on some pretty good investments.
(I love dividend investing. In fact, I am a self-proclaimed dividend investor, since I am trying to create passive income through dividend investing.
Nonetheless, my investing decision on dividend-paying stocks is in combination with a few other strategies.)
Some companies make you richer by NOT giving you dividend.
Berkshire Hathaway is one such company.
Berkshire Hathaway is one of the world’s most valuable companies run by the legendary value investor Warren Buffet himself.
Warren Buffet believes that he can allocate the earnings of the company much more efficiently for its shareholders compared to giving out dividends.
For the past few decades, Berkshire Hathaway has maintained an average of more than 20% return.
This double-digit rate of return has made Warren Buffet and many others who have invested in the early days of Berkshire Hathaway, a multi-millionaire.
For investors who only invest in stocks that give dividends, such investment opportunities may be missed.
Is this a good value-investing strategy for you?
Dividend investing is definitely a great strategy for passive income but there are a few limitations.
Nonetheless, there is some strategy that can help you in automating the dividend passive income in a relatively safe way.
Here are some reviews of the best investing books that may prove helpful to you.
3. The Long-Term Value Investing
Warren Buffett and his Vice-Chairman Charlie Munger are long-term value investors.
Hailed as the modern father of value investing, Warren Buffett is one of the richest men on earth.
For Warren, long-term investing does not mean 1 month, 1 year, or even a decade.
Investing for the long-term generally means buying the stocks with a mindset of not selling in the future.
Long-term value investors are not concerned about timing the market and deciding when they should sell their investments.
If a company is good with great fundamentals Warren Buffett would not only keep their investment but also increase their holdings.
While long-term value investing may be a simple strategy for most investors, it is not the easiest strategy.
Long-term value investing requires the investor to make at least 4 right decisions.
- First, they have to identify a company that is a great company.
- Then, they have to buy the company that is ‘on sale’.
- Then, after knowing that it is a great company, they have to resist the temptation of selling the company when the price of the company drops.
- Finally, they will need to know when the company is no longer a great company and is time to sell.
This sounds quite logical and seems to be just common sense.
But if you have experience in buying stock, you must have noticed there are something more before you can utilize this strategy.
- How do you know the company is a great company or good company or even a company on the verge of insolvency?
- When do you even identify a company that is ‘on sale’?
- Do you even have the courage to resist the temptation of selling the stock when it just drop 50% of its stock price in just 1 day?
- How will you know the company is no longer a great company and it is time to sell (exit)?
These are just some of the many question you will have to answer in order to make the right decision.
We human in general panic and sell when the price drop drops, it is just human nature.
Such a strategy requires in-depth knowledge of investing and a stomach to ignore the fluctuation of the stock market when required.
Long Term value investing example
John brought 100 shares of the stock at a price of $10.
For the next 6 months the stock drops to $5, he held onto the company because the company is a great company with a strong financial statement and currently is priced very low.
Thus, he brought another 100 shares at $5.
After holding the stock for 5 years the stock price has risen to $20.
John kept the stock to allow his investment to grow. As the company is still undervalued and is still a great company with a strong financial statement with high growth potential.
Is this a good value-investing strategy for you?
A long-term investment is a strategy that allows money to work for you over a long period of time.
It requires the least amount of time to manage your investment portfolio.
Furthermore, you won’t have to follow the news closely in regard to the company.
If you are a long-term investor, you only have to perform a periodic review of your portfolio.
As a long-term value investor, you’ll need to be knowledgeable in investing.
The value investor needs to know how to identify a great company. As well as having the know-how to calculate if the company is selling at a bargain price.
Finally, long-term value investor should not have their investment decision affected by market fluctuation.
Which Value Investing Strategy Is Suited For You?
You do not need to pick just one form of value investing strategy, often times successful investors create a hybrid of different investing strategies that suit their personality and risk-tolerance level.
- Buy Low, Sell High-Value Investors
- Passive Income Value Investors
- Long-Term Value Investors
Understanding your personality, risk tolerance, and learning the knowledge on investing are the building block to becoming a successful investor.
Finding the best strategy for you will require you to learn from the masters of the investing world.
Learning from these mentors is not impossible, in fact, they have made it easy for you to learn directly from people such as Warren Buffett and John C. Bogle.
Here are some reviews of the best investing books as well as a guide on which book suits your needs. This review article may prove helpful to you.
Read Also: Best Investing Books – Reviews & Buyer’s Guide
It is always great news when we want to take a proactive step toward learning and managing our own investments.
Value investing has made many rich beyond our imagination, but it is our responsibility to learn how to invest and take charge of our financial future.
Investing can help you to become rich.
But without the right knowledge, you are just gambling.
Investing is not for everyone.
But if you choose to invest, read more books on investing and invest in yourself.
“The more you learn, the more you earn.”
By Warren Buffett
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Antony C. is a dividend investor with over 15+ years of investing experience. He’s also the book author of “Start Small, Dream Big“, certified PMP® holder and founder of IncomeBuddies.com (IB). At IB, he share his personal journey and expertise on growing passive income through dividend investing and building online business. Antony has been featured in global news outlet including Yahoo Finance, Nasdaq and Non Fiction Author Association (NFAA).
