Intro to value investing
Value investing has been advocated by many professional investors, since it is initially defined by Benhamin Graham and David Dodd. The key point of Value Investing is to making investment decision based on a rational foundation. Over the last three or four decades, value investing has always been an important approach to investment analysis so today I would like to share what I have learnt from "Value Investing: From Graham to Buffett and Beyond" written by Bruce C. N. Greenwald and Barbara Kiviat.
There are three key features of financial markets in value investing:
- The price of financial securities can move significantly and randomly, which is determined by the market forces at any moment.
- Many of the financial assets have underlying or fundamental economic values that are relatively stable and that can be measured with reasonable accuracy by a diligent and disciplined investor. Intrinsic value of the security and the security current price are often two different things, though on any given day they may be identical.
- To get high returns in the long run, buy securities only when the market prices are significantly below the calculated intrinsic value. According to Graham, the gap between value and the price is called 'the margin of safety'. The ideal gap should close to one-half, but not be less than one-third, of the fundamental value.
As mentioned earlier, the investment decision is based on rational foundation. As such, a value investor should figure out the fundamental value of a financial security and compares the value to the current price in the market. If the current market price is lower than the fundamental value, then the stock should be undervalued.
P.S. As a calculation of risk, safety margin has nothing in common with the volatility of a security's price. The volatility can sometimes be high as the price is dropping very sharply, but to value investors it might not be risky but another investment opportunity as the margin of safety has also widened as well.
Reference:
Greenwald. B. C. N. & Kiviat. B. (2001). Value Investing: From Graham to Buffett and Beyond. Wiley.
