Why you would like to become a value investor? Because this is one investment strategy that can load heaps of profits over time.
But the trick lies in playing the value investing game right to its core.
What are the cores? Patience and knowledge.
– Patience helps to curb panic/urge that creeps in when market is doing bad.
– Knowledge helps to buy and hold good stocks for long term without getting perturbed by external volatility.
So patience and knowledge is all one needs to become a value investor.
In layman terms, pick only few right stocks and stay invested for long term. This can make you a value investor.
What means by right stocks? Stocks of fundamentally strong business at right price.
What means by long term? Buy and hold stocks for at least 7-10 years. Do not sell before.
How to do it? For this, one needs to know how to practice value investing.
How to practice? Lets read more…
#1. Intrinsic value?
Practicing value investing is simple.
Buy stocks at a market price which is lower than its intrinsic value.
Lower price means – application of margin of safety.
What is margin of safety? It is called application of two-third rule. What does it mean?
Market price = 2/3 x Intrinsic value.
If intrinsic value of a stock is Rs.100, and market price is Rs.66.67, this stock is said to displaying a margin of safety of 2/3rd (66.67%).
Intrinsic value means – fair price (or true value) of stocks.
How to know fair price of stocks?
There are several methods that can be used to estimate fair value of stocks. Few methods are listed below:
- Discounted Cash Flow Model.
- Benjamin Graham’s Formula.
- Net Current Asset Per Share model etc.
[Note: My stock analysis worksheet use 6 such methods to estimate fair value of stocks]
#1.1 Why to take the headache of calculating intrinsic value?
Intrinsic value means fair price of stocks.
One must buy stocks whose market price is below its intrinsic value.
This is called buying stocks at a discounted price levels.
Lets understand an interesting concept about intrinsic value.
Suppose you have decided to invest Rs.100,000 in a bank’s fixed deposit for 3 years.
You have an option to buy one from available 3 types of bank deposits:
- Loss: Here the bank deposit will reduced your investment from Rs.100,000 to Rs.99,000 (CAGR: -0.33%)
- Meagre Profit: Here the bank deposit will increase the value of your investment to Rs.105,000 (CAGR: 1.64%).
- Decent Profit: Here the bank deposit will increase the value of your investment to Rs.125,000 (CAGR: 7.72%).
Which fixed deposit you are likely to pick as your investment vehicle?
The decision is easy, the deposit which will give you highest returns (CAGR 7.72%) will be your pick, right?
Picking fixed deposits are easy because while buying, one exactly know what returns can be earned.
But stocks do not declare their potential returns. Investors must calculate it themselves.
If one does not perform this calculation, one may end up buying a loss making stock.
Hence to become a value investor, one must know to estimate intrinsic value of stocks.
Buying stocks at price below its intrinsic value will ensure a potential return as below:
#2. Value investing is not only about price?
Value investors will not buy “any” stock which is trading at discounted price levels.
They will buy only specific stocks. What means by specific stocks?
They will only buy stocks of fundamentally strong business.
What builds the fundamentals of a business?
Following are the parameters that must be referred, to understand the fundamentals of a business:
- Efficiency of Management.
- Profitability of Business.
- Financial Health.
- Future Growth Prospects.
- No threat to bankruptcy.
[Note: My stock analysis worksheet can be used to grade business based on the above parameters.]
#3. How you can become a value investor?
One must focus on the following:
- Intrinsic value calculation.
- Judge business fundamentals.
But over and above this, it is also essential for investors to keep their eyes open (knowledge gathering).
It is essential to be sensitive to what is happening around in the “economy”.
Key is to pick the new trends.
Example-1: If the new trend says, that India is increasing its self-reliance in defence sector, then following companies may benefit:
- Mahindra Group – Mahindra Defence Systems.
- Tata Group – Tata Advance Systems.
- L&T Group – L&T Heavy Engineering (defence and aerospace).
- Bharat Forge – Aerospace etc.
Example-2: If the overall economy is weakening then all stocks will suffer a price fall.
This may bring even the biggest stock’s price closer to its intrinsic value.
These two examples are only symbolic of what is the benefit of “knowledge-gathering”.
The more knowledge one has gathered, more informed will be the decision making.
How to gather knowledge? By reading reading and reading.
It is said that, the great value investor Warren Buffett invests 8-10 hours a day in reading.
More and more reading will also build “ones unique thought process”.
Having an independent thinking is a key in tapping good stock, before anyone else identifies it.
How you can become a value investor? This target can be achieved by starting to read more.
What one must read?
- Financial statementsof companies.
- Reading about how toestimate intrinsic value.
- Article published on fundamental analysis.
- Economic daily’s.
Try to build this habit.
If you are a beginner, give yourself 3 months starting time. Keep reading more and more stuff in this phase.
You can also identify your favourite sectors. Read more specifically about it.
This will build your circle of competence (knowledge about the sector).
The wider will be your circle of competence, more likely you are to find value stocks for yourself.
Have a happy investing.