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Value investing is a solid strategy for wealth generation. It involves buying stocks, real estate, bonds, or other assets for less than their actual worth.

Investors who pursue value investing aim to analyse a company's fundamentals and calculate its intrinsic value. From there, they look to purchase solid companies at or below their intrinsic value.

If value interesting interests you, then you are in the right place. This blog looks in detail at value investing - concept, strategies, pros and cons, how it compares with growth investing, best value shares on ASX, and key considerations when picking value stocks.

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1. What Is The Meaning Of Value Investing?

Value investing is an investment strategy that involves picking assets that appear to be trading below their book or intrinsic value.

Value investors are long-term investors of quality companies. They use financial analysis, stay patient and diligent, and don't follow the herd to find and invest in value stocks based on the value investment strategy.

2. How Do Value Investors Make Money?

Value investors look for market crashes or corrections when the share prices drop across the board. In such a scenario, they analyse well-established companies to find the ones trading at or below their intrinsic value.

They perform in-depth research and use various metrics to find the stock’s valuation or intrinsic value and whether the investment is attractive enough.

The assessment procedure involves analysing the following:
 

• Company's overall brand image 

• Business model

• Target market 

• Financial health analysis, such as the company's financial performance, earnings, revenue, cash flow, profit, and sales and revenue growth 

• Competitive advantage

• Comparison of financials with that of their competitors

• Various metrics include Price-to-book (P/B) ratio, Price-to-earnings (P/E) ratio, debt or equity ratio, and free cash flow. A company that pays out dividends and has stable revenue and sales growth shows the company is doing well financially. 

After the assessment, the investor concludes whether a company is worth more than the stock market’s expectations. If yes, then such companies are the beginnings of a value investment.

Based on their calculations, value investors have higher chances to profit from such deeply discounted shares.

3. What Is Value Investing In Stocks?

Value investing in stocks implies buying stocks available at discounted prices rather than their actual worth.

Investing in such undervalued stocks offers higher than average profits to investors than in other investing strategies.

Here are several factors that can exert downward pressure on a stock's value, leading to it being undervalued:

• Economic downturns 

• Market movement and herd mentality

• Negative news, events, and publicity 

• Market Crashes

• Unnoticed and Understated Stocks

• Economic downturns

• Cyclicality

Value Investors usually analyse the company’s financials and fundamentals to examine which stocks are undervalued and have the most future potential.

Fundamental analysis helps them evaluate and find companies trading at a discount to their intrinsic value. It is worth noting that value investing is a long-term investing strategy. Stocks can take many years to reach their intrinsic value and become lucrative.

Also, fundamental analysis is only partially accurate and conclusive. There can be chances that “seemingly value stocks” never reach their intrinsic value. This is a significant risk of the value investing strategy.
 

4. What Is The Difference Between Value Investing And Growth Investing?

Here is a detailed comparison of value investing vs. growth investing:

Is Value Investing Better? Value Investing can offer generous returns to investors; however, it also has its downsides. Understanding both will help you decide whether it is worth implementing:

Advantages of Value Investing

• It helps you find good potential and underpriced stocks that will help you reap spectacular gains in the future.

• Investing in value stocks also offers a margin of safety: the difference between the stock’s intrinsic value and the current market price.

• A value stock has the potential to become a multi-bagger stock. So, if an investor picks the right stocks, it can deliver them high profits.

• Value investing is based on in-depth fundamental analysis, tangible evidence, and solid fact-based research instead of speculation-based investing.

• A value stock's low risks and high reward ratio make the strategy promising provided the stock is adequately assessed.

• Value investing capitalises on the power of compounding that can magnify your investments if you reinvest your earned dividends and returns.

• Value investors consider the overall company's potential rather than market sentiments towards them. The strategy is relatively safer as value investors prioritise secure, stable blue chips over small caps.

• Value investing is less susceptible to the effects of market sentiments, economic environment, and hype and, therefore, needs less guesswork.

Limitations and Risks of Value Investing

• Any miscalculation may lead to heavy losses. This strategy suits only investors with a high-risk tolerance. 

• in a specific sector enhances portfolio risk that can lead to losses when the industry falls. 

• Value investing is a steadier and slower investment approach. For many, keeping immense patience to hold value stocks for years to maximise their intrinsic value makes it challenging, tedious, and time-consuming. 

• There is no certainty that value stocks will reach their full potential. Thus, uncertainty and long holding periods make value stocks risky.

• As most value companies hide and don’t gather much attention, identifying and investing in them is often tricky. 

• Estimating the stock’s intrinsic value needs expertise and specialisation in an industry that each investor may not have. You will require a thorough understanding of accounting and financial statements to find prospects worth committing capital to. 

• Value investing follows an approach that is against the market sentiment and trend. Going against the flow and betting against the herd requires self-confidence and staying happy buying when others sell. 

• Value stocks tend to be cyclical. They go through periods of stagnation followed by periods of outperformance. So, investors need a lot of patience when implementing this strategy.

Having seen the pros and cons of value investing, it ultimately boils down to what type of investor you are.

Suppose you are a long-term investor, prefer lower volatility assets, and have patience, good financial knowledge, and confidence in going against the crowd. In that case, value investing can be a profitable strategy offering generous rewards.

5. How Do You Value Invest?

Investment in value stocks is similar to . However, the strategy for finding and buying undervalued stocks differs.

Suppose you are considering value investing and want to know how to choose stocks for value investing. In that case, the following strategies will help you identify the best-undervalued stocks on the ASX:

Fundamental Analysis

Fundamental analysis involves finding a company's intrinsic value by reviewing its income statement, free cash flow, and balance sheet against its competitors.

Income Statement

Value investors should also see the history of operating profits generated by a business's core business activities (excluding interest expense and interest income).

Stocks with high margins relative to competitors are worth investing in, as profit efficiency can give them a competitive advantage.

Balance Sheet

A solid balance sheet is a sign of a stable company. A good value stock can pay its short- and long-term obligations. Reviewing metrics like the debt-to-equity ratio and working capital ratio can help.

Free Cash Flow

A company should have free cash flow to fund activities like dividends, share buybacks, etc. It is leftover cash after funding business operations and capital expenses.

When , investors should see a history of consistent rising free cash flow with a sluggish stock price. Such a stock can indicate solid returns ahead for its investors.

Valuation Metrics

Value investors use two key metrics or comparable ratios, price-to-earnings (PE) and price-to-book (PB), to identify whether a stock trades for more or less than its actual worth.

PB Ratio

This ratio compares the company’s market valuation to the asset’s value minus liabilities. An undervalued stock with a PB ratio of below one can be a good value stock for investment.

PE Ratio

This ratio tells the existing cost of each dollar a company earns. A stock with a lower PE ratio than its competitors is a good buy since you would pay less for the same earnings than its competitors.

Tips to consider when value investing:

• Always analyse the company’s fundamentals to determine its intrinsic value. It will help you find the right price to enter the stock.

• Be careful while calculating the intrinsic value, as any miscalculation might incur heavy losses. That's why only investors with high-risk tolerance should invest in value stocks. Seeking a financial advisor is helpful if you can't do these complex calculations and make investment decisions yourself.  

• Another fundamental principle of value investing is to invest in undervalued stocks. 

• Don’t follow the herd mentality. Instead, invest in the stocks that others ignore.

• Have patience and a long-term investment horizon to get the best returns.

One should make investment decisions based on your financial objectives, risk tolerance, time horizon, and other factors. A flexible portfolio of stocks that provides a reasonable growth path and earning level is likely to reap the best rewards on the investment.

6. Frequently Asked Questions (FAQs)

What is an Example of Value Investment?

Fundamental metrics like the price-to-earnings ratio show company earnings concerning their price.

A value investor may invest in companies with a low PE ratio as it provides a barometer to determine whether it is overvalued or undervalued.

Here is One of The Simple Value Investing Examples:

Let’s say the share price of Woolworths Group Ltd (ASX: WOW) is $40. It implies that the stock market has assigned a value of $40 per share to Woolworths.

After studying Woolworths's fundamentals, value investors might determine the share’s actual value to be $60 per share. So, the investor identifies mispricing in the stock. However, as per Buffett's advice, an investor may also employ a 50% margin of safety to avoid possible losses.

Thus, this investor will only consider buying the share when it falls to $30 per share, assuming that the market will revalue the stock at its 'true' value of $60 a share over time. Thus, the entire approach will result in a handy profit for a value investor.

What Are Value Stocks in Australia?

are undervalued stocks of high-quality businesses available at reasonable values. These stocks are available at discounted prices and are part of any long-term investment strategy.

Specific attributes of these stocks that appeal to value investors are:

• Mature and well-established businesses 

• A long operating history and track record of success

• Lower priced than the broader market and industry competitors

• Consistent performers 

• Stable growth rates, profits, and revenue streams

• Steady dividend payments

• Less risky than the overall market

Who Should Do Value Investing?

A good value share can lower the possibility of losing money and offer the potential to cash in when the market recognises the true worth of the company.

However, value investing requires patience as a value share mostly takes long enough to get repriced at a suitable and higher level. However, their return on investment can be sizeable for those willing to wait.

is ideal for risk-averse, patient investors with a long-term investment horizon who don’t expect short-term gains.

What Are The Pitfalls of Value Investing?

While value investing is often considered a low-risk investment strategy, it does have its critics:

1. In a bull market, the earnings multiples of several shares get lifted. It makes it highly tough to find undervalued shares at these times. Thus, value investors may require waiting for long periods to find any profitable investment opportunities. This doesn’t make it a suitable option for any investor.

2. Another value investing risk is allowing your emotions to control your investing decisions. For example, when the price of your purchased undervalued stock drops, fear sets in and can lead to panic and premature selling.That’s why value investors must perform a detailed analysis to determine that the stock they are purchasing is undervalued for a reason. It will help them keep it even if it slides a little. 

3. Also, value investors could fall into a value trap. It happens when a share looks cheap, but it is not. A value investor should watch out for a couple of situations that can produce value traps:

• Companies in cyclical industries often see a rise in share prices when their earnings rise during boom times, then fall when conditions cool off.

• Stock prices of companies that rely on intellectual property could rise if they have a high-selling drug treatment; however, they may fall if they lose patent protection and most of their profits quickly. 

• New entrants in the tech sector are also prone to value traps. Such companies can be the first movers in a new industry; however, they can only stay for a short time if they can protect themselves against the competition.

To save yourself from value traps, value an ASX share based on the company’s future growth potential rather than its past performance. Focussing on a company's future sales and earnings growth in the coming months and years could get you good value shares.

How Many Value Stocks Should You Own?

Choosing 10 to 30-value stocks is an excellent way to diversify your holdings.

However, rather than exclusively pursuing value investing, a better way could be to follow a blended investment strategy wherein you buy stocks in both growth value and growth stocks categories. The returns you get by this strategy depend on which is outperforming.

Investors with small capital can include up to six stocks, preferably in different industries, provided you have researched their price action, historical trends, and fundamentals.

Always seek the help of a professional financial advisor before making any investment decision. Investing carries risk. The above are just some general options for educational purposes. All these options come with risk. This is not financial advice.

Do Value Stocks Pay Dividends?

Yes. Though it is not a necessary qualifying criterion for a value stock, most pay dividends to its investors.

Due to being mature and well-established companies, value stocks pay higher dividend income than the average growth stock.

What is The Concept of Value Investing?

Value investing is one of the four major strategies besides momentum, dollar-cost averaging, and growth.

It is a long-term strategy to invest in stocks that appear undervalued and seem to trade for less than their intrinsic value. This way, value investors buy stocks at a highly discounted price to sell them at a higher price and earn fat profits.

The strategy involves going against general market trends and picking stocks that the market underestimates. As stocks may take a while to attain their intrinsic value, value investing can take years before yielding profits.

Is Warren Buffett a Value Investor?

Yes. One of the legendary investors, Warren Buffett, is classified as a value investor.

What is Warren Buffett's Value Investing?

Warren Buffett is regarded among the most eminent value investors. As per this legendary investor, you don't lose money if you purchase things far below their price (undervalued stocks) and buy a group of them (diversify).

It is the essence of how a value investor thinks and invests.

How Are Value Stocks Different From Growth Stocks?

Value investing and growth investing are two main types of investment strategies. Investors look for different kinds of stocks in both of these strategies.

If you are still deciding which stocks to buy, the below comparison of value vs. growth stocks will help you make the right choice.

Growth Stocks

These stocks belong to companies experiencing rapid revenue growth significantly exceeding the market average. Additionally, they demonstrate several other characteristics, including:

• Primarily operates in the technology sector

• High-revenue growth companies with low earnings or net losses

• High user growth metrics

• Growing costs – primarily due to expansion or talent costs

• A Price-to-earnings multiple

Some ASX growth stocks examples (with share price) in 2023:

• Technology One (ASX: TNE), A$14.93

• Seven Group (ASX: SVW), A$24.67

• Promedius (ASX: PME), A$61.76

• Perseus Mining (ASX: PRU), A$2.11

• Flight Centre (ASX: FLT), A$19.43

• Sandfire (ASX: SFR), A$5.98

• Premier Investments (ASX: PMV), A$27.94

• Webjet (ASX: WEB), A$7.00

• AUB Group (ASX: AUB), A$27.36

Value Stock Characteristics

Value stocks are the stocks of well-established businesses with a long history of success. They become highly appealing for long-term investors when available at less than their intrinsic price.

Some of their specific characteristics include:

• Mature businesses 

• Consistent profits

• Steady growth rates

• Constant revenue streams

• Fixed dividend payments

• Lower priced than the broader market and industry competitors

• Low-risk than the general market

While growth stocks in Australia offer above-average earnings growth despite poor economic conditions, value stocks tend to stay steady and maintain continued growth, consistent revenues, and profits.

7. Conclusion

Value investing is among the most successful strategies for stock investing.

However, it has its drawbacks. As value investing requires immense patience, ensure it suits your investing temperament before you follow this approach.

Using value investing principles and other strategies could be the best way to compensate for its pitfalls and maximise your returns.

If you still need a share trading account, consider , which is used by many investors in Australia and worldwide. You can create an .

eToro Service ARSN 637 489 466 promoted by eToro AUS Capital Limited ACN 612 791 803 AFSL 491139. Capital at risk. See  and .

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