Thursday, 18 July 2013

If you know the true value of something, buy these only when they're on sale

The basic concept behind value investing is so simple that you might already do it on a regular basis. The idea is that if you know the true value of something you can save a lot of money if you only buy things when they're on sale. 

Buying stocks at bargain prices gives you a better chance at earning a profit later when you sell them. It also makes you less likely to lose money if the stock doesn't perform as you hope. This principle, called the margin of safety, is one of the keys to successful value investing. 

Unlike speculative stocks whose price can plummet, it is less probable that value stocks will continue to experience price declines. 

Value investors don't buy the most popular stocks of the day (because they're typically overpriced), but they are willing to invest in companies that aren't household names if the financials check out. They also take a second look at stocks that are household names when those stocks' prices have plummeted. Value investors believe companies that offer consumers valuable products and services can recover from setbacks if their fundamentals remain strong.

Value investors only care about a stock's intrinsic value. They think about buying a stock for what it actually is - a percentage of ownership in a company. They want to own companies that they know have sound principles and sound financials, regardless of what everyone else is saying or doing.

Value investing is a long-term strategy - it does not provide instant gratification. You can't expect to buy a stock for $66 on Tuesday and sell it for $100 on Thursday. In fact, you may have to wait years before your stock investments pay off. (The good news is that long-term capital gains are taxed at a lower rate than short-term investment gains.)

What's more, value investing is a bit of an art form - you can't simply use a value-investing formula to pick the right stocks which fit the desired criteria. Like all investment strategies, you must have the patience and diligence to stick with your investment philosophy even though you will occasionally lose money.

Also, sometimes you'll decide that you want to invest in a particular company because its fundamentals are sound, but you'll have to wait because it's overpriced. Think about when you go to the store to buy toilet paper: you might change your mind about which brand to buy based on which brand is on sale. Similarly, when you have money saved up to invest in stocks, you won't want to buy a stock just because it represents a share of ownership in your favorite company - you'll want to buy the stock that is most attractively priced at that moment. And if no stock is particularly well priced at the moment, you might have to sit on your hands and avoid buying anything. 

(Thankfully, stock purchases, unlike toilet paper purchases, can be postponed until the time is right.)

No comments: