Different sources define value investing differently. Some say value investing is the investment philosophy that favors the purchase of stocks that are currently selling at low price-to-book ratios and have high dividend yields.
Others say value investing is all about buying stocks with low P/E ratios. You will even sometimes hear that value investing has more to do with the balance sheet than the income statement.
Learning From the Master
In his 1992 letter to Berkshire Hathaway shareholders, Warren Buffet wrote:
“We think the very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).”
“Whether appropriate or not, the term ‘value investing’ is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinate. These measures don’t definitevly represent whether an investor is indeed buying something of worth and is therefore truly operating on the principle of obtaining value in his investments.
Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – while not the usual choice for value investors, are not necessarily bad investments. Buffett’s definition of “investing” is the best definition of value investing there is. Value investing is purchasing a stock for less than its calculated value.
Tenets of Value Investing
- Each share of stock is an ownership interest in the underlying business
A stock is not simply a piece of paper that can be sold at a higher price on some future date. Stocks represent more than just the right to receive future cash distributions from the business. Economically, each share is an undivided interest in all corporate assets (both tangible and intangible) – and ought to be valued as such.
- A stock has an intrinsic value
A stock’s intrinsic value is derived from the economic value of the underlying business. In addition to the economy value of its financial statements and assets there are also other factors. A good track record and experienced management team is also a huge consideration when making a value investment. Business plans and the ideas underlying the business, like technological advances, or its sales model must also be considered.
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