For decades, investors have been oscillating between two main investment strategies—growth and value investing. In fact, these two investing techniques take turns to dominate the market and they tend to move in cycles. From 2000 to 2007, value investing techniques were ruling the market. However, from 2007 to 2020, growth investing led the way. Subsequently, as soon as the market witnessed a major shift, value investing made a comeback and continues to hold sway. In other words, investors need to focus on a business’ quantitative and qualitative factors before investing. Let’s delve deeper into the role of value investing and why it requires adaptation and resilience.
What is Value Investing and Why is it Important in a Changing Market?
Value investing is an investment philosophy that focuses on investing in stocks that are valued at a lower price than their intrinsic value (book value).
Let’s understand this better. Say, you invest in the stocks of a company whose financials look good and the company is expected to grow exponentially. Based on its business model, product, and other factors, the intrinsic value of the company should be $100. However, its stock is available at $50. You purchase the undervalued stock at $50, which is expected to give high returns in the future.
This is called value investing. You buy stocks that are expected to grow rapidly in the next few years, at a lower price. This investment strategy is based on the principle that the market will soon realize the value or potential of a company and the price of the stocks will increase significantly in the next few years.
Value investing is a smart strategy in the changing market, especially during economic downturns when the market is bearish. During a recession, while some investors avoid purchasing stocks due to fear of loss, value investors take advantage of the bear market. They find high-quality companies and purchase the stocks at a lower price. Once the market gets better, they are able to generate high returns from their investments.
How Can Value Investors Adapt Their Strategies to Fit the Shifting Market Conditions?
Finding the correct intrinsic value of stocks is extremely critical for value investing to generate profits. However, this is also very challenging. To figure out whether a company has growth potential, value investors need to analyze the cash flow, earning stability, and debt ratios. In addition to financial performance, industry trends and competitive advantage are also extremely relevant.
Earlier, value investing principles by Benjamin Graham, the father of value investing, were based on a quantitative approach. He focused on finding intrinsic value through the financial statements of a company. Business magnate and investor extraordinaire Warren Buffett, however, stresses the importance of qualitative factors like management, industry dynamics, consumer behavior, and more.
Here’s a rundown on Buffett’s four-pillar ideology on value investing:
1. Circle of Competence
To begin with, value investors must invest in such businesses in which they have expertise or at least have some know-how. This gives investors a competitive advantage over other value investors
2. Build a Moat
In ancient times, rulers built a moat around their forts to protect them from attacks. Similarly, value investors should change their approach as per the change in market conditions and invest in companies that have a high competitive advantage based on their product, early market entry, and so on.
3. Able and Trustworthy Management
Furthermore, they should focus on companies that have an able and trustworthy higher management. In fact, the management should be competent enough to balance the interests of all stakeholders even during adversities.
4. Sensible Price Tag
Lastly, they should find out the company’s true market value through various methods such as discounted cash flow analysis and asset-based evaluation.
What are Some Successful Examples of Value Investing in a Changing Market?
Some of the best examples of value investing stocks in a changing market are:
In 2010, Visa, along with MasterCard, lost around $13 billion of its market cap because stringent regulations were imposed on companies facilitating digital financial transactions. Earlier, its shares dominated the debit market in the U.S. but later suffered a loss of 26%. However, within a month, Visa’s share price increased to around 19 times the expected share price for 2011.
Even though Oracle’s stock has seen ups and downs in the past four decades, the company has been a star performer. Its price suffered a huge blow between 2000-2002. However, in 2002, the share price of the company was still 27% higher than in 1999. Again in 2019, the shares were able to recover all the losses suffered in the past year, making it a value investing stock.
3. Home Depot
The largest home improvement retailer in the U.S., Home Depot’s share price was severely hit in 2008 when recession led to the collapse of the housing market. However, post-pandemic, its dividends rose by almost 1240% since the last decade, helping investors get huge returns.
What are the Key Factors to Consider When Building a Resilient Value Investing Portfolio?
Resilience in investment refers to liquidity or the ability of a market to return to a normal price after massive fluctuation in the market. Here are some factors that determine a resilient value investing portfolio:
Building a multi-investment portfolio, that has different expected risks and returns, protects you against events that would affect specific investments.
2. Margin of Safety
The difference between the intrinsic value and the current value of the shares provides a margin of safety to the investors. Moreover, a higher margin of safety makes the portfolio more resilient.
3. Low Debt Levels
Assess if the companies have a lower debt ratio as they are more likely to survive economic challenges.
4. Stable Dividend Distribution History
Investing in companies with a consistent dividend payment track record can provide you with a steady income.
Explore Finance Courses Offered by Emeritus
As explained above, adapting to changing conditions and resilience are the two core value investing principles that help maximize profits. Additionally, investors also need advanced financial and business knowledge to make sound decisions. If you are planning to build a career in value investing as an analyst or associate, Emeritus offers courses to help you learn the fundamentals of investing, value investing principles, value investing techniques, and other investment strategies. Explore Emeritus’ online finance courses to build a successful career in value investing.
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