Popularised by Warren Buffet, value investing is a strategy in which you actively pick out stocks that you think are trading for less than their book or intrinsic value, at discounted prices on sale. To learn more about value investing, you may check out the book on Margin of Safety by Seth Klarman.It can be loosely compared to buying electronics during sales instead of at full price.
If you are intrigued by this strategy, here are 5 techniques that will help you with value investing:
- Selective Trading: This technique requires you to make informed and educated guesses, since it means that you pick stocks which are poised to perform better than the market over a year or less. You need to keep track of factors such as government regulations, patents, competitive movements, etc.
- Long-Pull Selection: This mostly involves startups and newer companies that promise significant growth through their progress, business model, and other factors. They are often called “growth stocks”. Long-pull selection refers to investing in the prosperity of these enterprises over the years, in comparison to the average company.
- Bargain Purchases: If you use this technique, you will pick out shares selling significantly lower than their true value based on measurement techniques. The most popular technique for finding out if a stock is overvalued or undervalued is the P/E (price-to-earnings) ratio.
The P/E ratio can be calculated by dividing the share price by the company’s earnings per share (EPS). The EPS is calculated by dividing company profits by outstanding shares.
For example, there is company X.
- It has made $1 million in profits with 1,00,000 outstanding shares.
- Its EPS would be $10.
- The share price is $40, hence the P/E ratio would be 4.
What you need to do now is compare this P/E ratio with those of similar companies in the same sector.
- Index Investing: Index funds are passively managed, and hold securities based on the same ones that an underlying index holds. This technique is appealing since it takes a minimal amount of work, charges low fees, provides diversification, and gives you returns in proportion to the market a particular fund tracks.
- Socially Responsible Investing: Back when online stock market investing did not exist, and you could not conveniently online open demat account. As such, socially responsible investing wasn’t quite popular, but has come to grow in recent times. You select companies which try to tackle social issues such as gender equality, racial equality, climate change, etc., while reaping returns as well. You can always keep track of a company’s ESG (Environmental, Social, and Governance) rating, and its position in the SRI (Socially Responsible Investing) index.
There is no correct answer to which techniques you should follow. Once you get into the habit of research and practice, you can rationally use data and facts in order to mitigate risks, and maintain safety and liquidity.