Value investing was first developed and made popular back in the 1930’s by investor Benjamin Graham. The most well known disciple of Graham is Warren Buffett, the billionaire investor and chief executive officer of holding company, Berkshire Hathaway.
The concept, or central principle, of value investing, as explained by Graham, is to purchase companies whose current stock price is actually below the value of the underlying company itself.
Value investing requires research and patience. It is not about trading, and it’s not about stock price, it’s about getting value for your investment by purchasing good companies that are currently undervalued by the market.
In order to make value investing work, you must be able to determine an accurate estimate of what a company is worth and then compare this to its current stock price.
Finally, when you’ve discovered such a company, a decision must be made on whether or not to buy stock in it. Graham even preferred safety net, or margin of error by looking for companies selling up to thirty percent below their value.
The idea behind value investing was to minimize downside risk and look to generate a solid profit when the market catches up and the company stock prize becomes fully realized.
The concept of spreading your risk over a number of companies or industries is not applicable to value investing. The risk is managed within the research and selection process for the individual company. Graham reasoned that, while it could happen temporarily, it’s unlikely for a company’s stock price to stay below it’s actual value for the long term.
So why isn’t this type of investing very popular? Especially given the name recognition and success of Warren Buffet?
When there is a bull market, value investing tends to under-perform. It’s also a long term strategy that requires patience, something many investors lack when they see the price of other stocks shooting skyward.
Most investors nowadays are looking for that one golden stock, that grand slam about which investing stories get told years into the future. Of course, with that philosophy, risk is high. When the market turns, those are the investments that plummet, something that isn’t the case with a good value investment play.
It’s also true that many value investing companies would be considered “boring” such as consumer cyclicals, insurance companies, etc.
Warren Buffett has followed Graham’s advice very closely and Berkshire Hathaway has returned an amazing compound growth rate of 27.5% from 1967 to 2007.
There aren’t many money managers or investing companies with a long term track record like that. And Buffett does it by sticking to the value investing basics, finding good companies that are under-priced by the market.
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