When you start investing, one of the first concepts you’re likely to encounter is “value investing”. Like many terms in investment, “value” is not easy to pin down precisely.
As Charlie Munger, the business partner of famous US investor Warren Buffett, put it: “All investment is value investment, in the sense that you're always trying to get better prospects than you're paying for.” This is true, but not very helpful. So let’s be more specific.
At the heart of value investing lies the idea that a company’s share price is often very different to its “intrinsic value”. This disparity is often driven by market mood swings rather than rational analysis. So a value investor calculates the “intrinsic value” of a company, and then looks to invest when its share price is below that. A value investor also looks for a “margin of safety”. That is, they want to invest when the company is not just a little bit, but a great deal cheaper than its intrinsic value, in case their assumptions are wrong.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
How do you calculate intrinsic value? By analysing a company’s accounts. Traditionally, value investors look particularly closely at the assets on a company’s balance sheet – its book value. The idea is that if a company trades for a lot less than the value of the assets it owns, then in theory, you could buy the company, shut it down, sell all its assets, and still profit.
There are two big risks for value investors. One is that they buy companies which will never regain their past glory. For example, some companies only look cheap because their business models have been destroyed by new technology. These are known as “value traps”.
The second risk is summed up in the apocryphal quote from John Maynard Keynes, who as well as being the 20th century’s most famous economist, was also a brilliant investor. As Keynes said: “The market can remain irrational for longer than you can remain solvent.” In other words, sometimes even good quality value stocks remain out of favour for longer than the average investor can endure holding onto them, in the face of massive underperformance. This highlights the most important trait for the value investor: patience.
For more on value investing, subscribe to MoneyWeek magazine.
-
Barclays bank caps in-branch cash deposits for personal banking customersNews Barclays has placed a cap on how much you can pay into your bank with cash in a bid to fight financial crime - will you be affected?
-
State pension warning as families opting out of child benefit hits record highUp to one million parents could be losing out on £6,500 in retirement because they have opted out of receiving child benefit.
-
What is an investment trust?Videos “Active” investment funds come in two main varieties, one of which is investment trusts. But what exactly is an investment trust?
-
What is a dividend yield?Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
-
High earners to pay nearly £2000 more in tax due to fiscal dragVideos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
-
What is a deficit?Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
-
Too embarrassed to ask: what is moral hazard?Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
-
Too embarrassed to ask: what is contagion?Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
-
Too embarrassed to ask: what is a marginal tax rate?Videos Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
-
Too embarrassed to ask: what is stagflation?Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
