Written by Jocelyn dela Dingco, ZUU Online
There’s an increasing interest in value investing these days, not only in Singapore but in markets elsewhere. However, because the term has become synonymous with Warren Buffett, this investing strategy appears daunting to many investors.
They carry the notion that only those with the insight and stature of the well-known investor could achieve success. There are major misconceptions about value investing that needs clarification.
The 5 major myths of value investing
Warren Buffett has been characterized as the shrewdest investor around. All his investments turn into gold. And losing is not his option. His secret is attributed to value investing. He is able to take absolute control of his investments by using this approach. The predicted end result is profit and zero-losses.
Following are the myths surrounding value investing:
1. Value investing involves a comprehensive analysis of fundamentals
Before the digital age, securing financial information of a specific company is difficult and sometimes costly. Today, life has become easier for investors, particularly those engaged in value investing.
Many have the notion that value investors go through an extensive process of evaluation before arriving at an investment decision. In reality, they only pick a number of fundamental indicators. Nearly all financial data is accessible on the net. Company websites, stock market online platforms, and business news sites have them.
Research work is no longer tedious but has been simplified to suit value investors. Fundamental indicators such as financial and profitability ratios need not be computed manually. The data available can cover from 5 to 10 years ago. Value investors are basically spoon-fed with free, valuable information.
2. Value investors are bargain hunters
Value investors are mistakenly referred to as bargain hunters. In truth, buying stocks at low or bottom prices is not the key to value investing. Value investors have developed the practice of comparing stock prices to the true or intrinsic value of a company. Their main focus is not actually on low-priced stocks.
For them, pricing is relative. A stock worth S$20 would look cheap but still overpriced when fundamental analysis is applied. Inversely, a stock that is priced four times more could be a bargain.
In fact, purchasing a high price to book stock or a high price to earnings stock is also not a value purchase. TJ Tan, CFA, DCG Capital, explains, “Stock trading at high price to book, may have a lot of value, if the assets are carried at historical cost and in no way reflect the current market value of the assets. Similarly, a high price to earnings stock may not reflect the value of its potential earnings or it may just be the case that current earnings are temporarily depressed.”
Tan quotes Buffett: “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”
Tan believes that any serious investment operation must involve the effort to determine the value of the business and purchase the security below this value. “Where we and others differ is on the margin of safety (i.e. the gap between the value we estimate, and the price we pay) before we take a position in the security. If the value is only slightly higher than the price, the effort involved in purchasing the stock, monitoring the company, and the inherent imprecision of estimates means that this is hardly a profitable use of our energies.”
Value investors are proficient in determining whether the price of an equity issue reflects the real value of the company. Hence, there is no fixation on low-priced stocks but rather it’s getting your money’s worth in return.
3. You don’t lose in value investing
This is perhaps the biggest myth about value investing. Investing in the stock market is a risky business that no strategy can contain the market characteristics and win every time. Value investing is just one of the many strategies that can bring windfall as well as a financial setback.
If you look at the psyche of investors, they look for buy or sell signals. There is a prior evaluation before acting on a trade. No one goes on a buying spree without prior analysis. Otherwise, it would lead to losses.
What value investing does is to enable the investor to weed out high-risk choices. Only a few stocks that meet the parameters are left to add to the investment portfolio. Value investors would claim theirs is the best to profit in the stock market. But naturally, fundamental and technical analysts would beg to disagree.
4. Value investors are experts in finance and accounting
Another misconception is the belief that value investing is reserved for financial geniuses and certified accountants. It is true that financial statements and other financial data are complex and difficult for the layman to understand.
Accountants prepare the financial documents and assign the labels to accounting entries in the income statements and balance sheets. However, reading financial statements is a different matter.
Value investors do not prepare the financial reports themselves. It’s the analysis of the contents they’re good at. The financial ratios and profitability ratios would influence investment decisions.
Therefore, value investing does not require financial or accounting expertise. What is important is to develop analytical skills to make well-informed investment decisions.
5. Growth stocks are better choices over value stocks
When it comes to returns, growth stocks deliver higher returns as opposed to value stocks. Growth stocks usually ride on popularity which investors do not ignore. Companies whose equities are classified as growth stocks are often expected to report better-than-expected earnings. It means that the prices of rapidly growing stocks are above the average stock prices.
In reality, value stocks and growth stocks have just about equal chances of prevailing in the stock market. A major risk found in growth stocks is its tendency to outperform the market in the course of growth spurts. However, prices fall sharply and quickly when the spurts end.
Value investors generally favor long-term investments because value stocks are less prone to crash, unlike growth stocks. They are conscious of the infamous dot.com bubble happening again. Over the long-term, value stocks would deliver the desired returns at minimal risk.
Diversification is still the best bet
If you dig deeper to analyze value investing as a strategy, it boils down to one basic plan – diversification. Buffett is guided by the investment principle of Benjamin Graham who is the acknowledged proponent of value investing.
Buffett stated, “I bought a large number of stocks in small amounts, in companies whose names I couldn’t pronounce. But the stocks as a group were so cheap, you have to make money out of it, it was Graham’s kind of stocks.”
Essentially, what is clear now is that Warren Buffet is playing it safe. By buying a multitude of stocks from various industries, the investment will produce winners more than losers. It would be an overall gain in the end.
Value investing is just one of several strategies applied to stock investing. If the strategy guarantees winning trades, then we don’t need to rely on the other methods to make decisions. Value investing gives out false impressions and investors should know what’s the real score.
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This is a guest post by ZUU Online, an Asian-based Finance Education Portal aimed at helping individuals to improve their knowledge on personal finance and money, through educational articles on business, investments, property and insurance.
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