Value Investing

What Is Value Investing?

Value investing is a strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value. Value investors actively search for companies they think the stock market is underestimating. They believe the market overreacts to both good and bad news, resulting in stock prices that often do not correspond to a company’s long-term fundamentals. 

This market overreaction offers an opportunity to profit by buying stocks at discounted prices.

Warren Buffett is probably the best-known value investor today, but there are many others, such as Jim Rogers. Rogers once said the following: “I just wait until there is money lying in the corner [ignored by Wall Street], and all I have to do is go over there and pick it up.”

Value investors hope, as seasoned market observer Jim Grant said, “…have people agree with you… later.”

Value investors use a number of various metrics to try to find the intrinsic value of a stock. Intrinsic value is a combination of using financial analysis such as studying a company’s financial performance, revenue, earnings, cash flow, and profit as well as fundamental factors, including the company’s brand, business model, target market, and competitive advantage. 

Some metrics used to value a company’s stock include: price-to-earnings, ratio, price-to-book ratio and free cash flow.

The Difference Between Value and Growth Investing

Value investing involves searching for stocks trading below their actual value. Quite often, these involve mature ex-growth industries, such as utilities and banks, as well as cyclical industries such as banking, energy and mining stocks. 

Growth investing is all about finding companies that show above-average revenue and earnings growth potential, such as technology stocks.

In effect, growth investors are looking for a company at $100 a share and that will go to $200, relatively quickly. Meanwhile, value investors are looking for a company trading at $50 a share that will go to $100 within a few years as the market recognizes its true worth. 

Growth investors, unlike value investors, have little interest in current income from their portfolio. Also, growth investors do not mind highly volatile stock prices because they do not need the money until well into the future.

These two investing strategies have waxed and waned in popularity historically.

In 1997, Nobel laureate Eugene Fama pointed out that value stocks had beaten growth stocks over the long term. This “discovery” was followed by the bursting of the tech bubble in 2000, and value stock prices outperformed growth by 16% over the next five years.

However, by 2005 value stocks became overpriced. And as an issue of the Journal of Banking and Finance pointed out – value investing stopped ‘working’ in most developed markets in the last 15 years.

In simple terms, when the markets are greedy, growth investors win and when they are fearful, value investors win.

Why Choose Value Investing?

For long-term investors, it is this very waxing and waning that means value stocks should be part of your portfolio.

Data from 1927 through 2020 showed that small value stocks had a return of 14.3% annually, and large value stocks had a return of 11.8% annually. During the same period, large growth stocks had a return of 10%, and small growth stocks had a return of 9.3%.

From 1927 through 2019, according to the data compiled by Nobel Prize laureate Eugene Fama and Dartmouth professor Kenneth French – over rolling 15-year time periods – value stocks have outperformed growth stocks 93% of the time. However, when looking at year-by-year performance, value outperformed growth just 62% of the time.

Currently, in a rising interest rate and inflationary environment and with growth stocks outperforming in the decade from 2010 to 2020 – value stocks are poised for a period of outperformance over growth again.

The old debate of growth investing vs. value investing will go on and on. However, history tells us that value stocks outperform over time, even if growth stocks steal the daily headlines. 

So if you’re buying individual stocks, stick to fundamental investing principles of Warren Buffett. Or consider buying a broad-based value index fund that takes a lot of the risk out of stocks over the long term.  A simple search on Magnifi indicates numerous ways for investors to access value funds with low fees. 

Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.

The information and data are as of the November 8, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.