Out of different methods of investing, one widely followed style is Value investing. Famous investors like Warren Buffet, Kenneth Fisher, Peter Lynch, Charlie Munger, and Benjamin Graham follow the Value investing style.
Value investing is the art of picking stocks that are trading below their intrinsic value. Sometimes markets overlook a few stocks and proceed in their course; finding these stocks requires digging deeper into financials and business and management abilities to steer the company through different market cycles.
Thus, a value investor tries to pull out the hidden value of a product or investment by a paying low price.
“Price is what you pay, Value is what you get” is one of Warren Buffet’s best quotes. What is price and what is value?
To understand the true essence of value and price, let us go through a case study.
Suppose a construction company has a newly constructed property in prime areas of a famous city, but due to the delay in approvals required as per government norms, the company cannot sell its projects for the last 2 years. Due to this, the top line (Revenues of the company) declined. So financial statements (P&L, Balance sheet and Cashflow) are not looking attractive. Eventually, the share price dropped by 25%.
But when the company received necessary approvals from the government. Their projects sold like hotcakes, and over the next 2 to 3 years, the company's P&L, Balance Sheet and cash flow statements started to grab the attention of many investors, including DIIs & FII, and the stock price soars up by 200%.
Therefore, for a value investor, understanding the company's business (in this case, understanding the construction company's business activity) and unearthing the true potential that a company can deliver is equally crucial as reading financial statements and arriving at an intrinsic value.
Any investor who can understand and estimate the true potential of the above said construction company would not be selling this stock at a low price (I.e., in phase 1). Instead, he would choose to buy the stock or increase his exposure to the stock when the stock price is low, as in phase 1 in the above case and reduce his exposure to the stock or sell in phase 2, i.e., when the stock has achieved its potential.
Thus, in the above illustration, phase 1 is the undervalued stage of the stock and phase 2 is the fair to an overvalued phase of the stock.
Value investing not only focuses on returns but also maintains the margin of safety and brings capital protection & satisfaction of buying a product/stock at a fair price and a feeling that we haven't overpaid for our purchase makes us stay in the investment for longer periods.
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