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Created on 10.03.2023

Value investing as an investment strategy

When investing money, you have a variety of options, not just in terms of instruments, but also in terms of investment strategy. One of those is value investing. Among other things, this provides for the purchase of shares when a company’s share price is undervalued. Are you wondering what exactly this involves and whether the value investing strategy is also suitable for you? We clarify and classify.

What is value investing?

Value investing is an investment strategy that aims to purchase shares below their intrinsic value . In other words, these are shares that appear undervalued. In a nutshell, it works as follows: Investors try to determine the true value of a company independently. This can often be undervalued or overvalued on the stock market, due to current events such as pandemics or financial crises, for example. Knowledge of the intrinsic value of the shares or company gives value investors the opportunity to make a good deal when the shares are undervalued. This is because investors who follow the value investing strategy assume that the market will overreact to events – both positive and negative – and are always guided by the intrinsic value of shares. They try to determine this based on various financial key figures. For example, with the price/earnings ratio (P/E), the price/book ratio (P/B), the dividend yield, the debt-equity ratio, and the earnings growth.

How is value investing different from growth investing?

While value investors focus mainly on fundamental data such as current quarterly figures or past results when selecting shares, growth investors try to anticipate future growth in markets and industries. Because these are often trends, prices can skyrocket due to high demand, leading to overvaluation. The situation is different for value investments, where the focus is on financial valuation and the purchasing of shares in undervalued companies. Find out more in our article “Growth Investing as an Investment Strategy”.

How does value investing work exactly?

The value investing strategy exploits the typical behavioural patterns of investors who act emotionally. This is because, fearing losses, they follow the impulse to sell their shares when prices fall. By focusing on fundamental data, value investors identify stocks that they believe to be undervalued in the current market and purchase them at a lower price than their intrinsic value. With their assumption that the acquired shares are undervalued, they rely in particular on analyses of financial data of the company rather than the share price.

Reasons the price of a share may deviate from the company’s value

  • Economic downturn: Investors sell in panic. As a result, the share price falls below the true value of the company.
  • Psychological biases: These can drive a stock price up or down based on news such as disappointing or unexpected profit announcements, product recalls, or litigation.
  • Shares are traded under the radar: This happens, for example, when analysts and the media do not report on them adequately. As a result, shares may be undervalued.

By focusing on fundamental data, value investors identify shares that they believe to be undervalued in the current market and purchase them at a lower price than their intrinsic value.

When is the right time to buy shares that are supposedly undervalued is a legitimate question that even value investors have to ask themselves time and again. However, there is no objective answer to this question. A fixed safety margin can help with the purchasing decision. As an investor, you determine the minimum ratio between the price of the share and the intrinsic value that you determined in order to purchase it. For example, if you believe that the share price may be a maximum of two thirds of the company value, this means that for a share with a company value of 100 francs, the current share price may be a maximum of 67 francs. On the one hand, this gives you sufficient leeway for possible misjudgements in the company valuation. On the other hand, the safety margin gives you the chance to improve your profits in the long run. This is because the further the purchase price of the share is below the actual company value, the more opportunity you have of making a profit in the long term. Provided, of course, that your value assessment proves to be correct.

What does Warren Buffett have to do with value investing?

When value investing is mentioned, it is usually not long before the name “Warren Buffett” comes up. He is one of the best-known and most successful value investors and has played a key role in shaping value investing strategy as we know it today. His philosophy and approach are often quoted. For example: “Price is what you pay; value is what you get”. There are other well-known value investors besides Warren Buffet. These include Benjamin Graham, Warren Buffett’s professor and mentor, and David Dodd. Benjamin Graham is considered the father of fundamental security analysis, the basis for value investing. He used key figures such as price/earnings (P/E) ratio, price/book (P/B) ratio, dividend yield, debt-equity ration and earnings growth to determine the intrinsic value of a share. Together with David Dodd, he also wrote the well-known book “Security Analysis”, which describes in detail techniques for the fundamental analysis and valuation of companies.

Nine points that you must consider when investing according to the value investing approach

Although no investments or investment strategies are risk free, the value investing approach is generally considered to be lower risk than other methods. This is primarily due to the key figure-based analyses used to determine value, which also include data from previous years. However, there are some issues you should be prepared to deal with if you want to invest using the value strategy:

  • Trend investments are often overpriced and their performance depends on future rather than past results. They are therefore not suitable for value investors.

  • As a value investor, your primary source of information is a company’s financial data. You should therefore give greater weight to these than to market opinions or to the previous price performance of a share.

  • This sounds like a contradiction to point three, but it is not. To know when it is worth buying because assets are undervalued, you need to know what is currently occurring in the market.

  • Conducting a lot of research and analysis to determine the intrinsic value of a share takes a lot of time. The opportunity for long-term profits therefore requires a great deal of personal commitment from value investors in addition to their capital.

  • As a value investor you will often trade counter-cyclically to improve your chances of buying undervalued shares. In other words, you will tend to buy when others are selling. The value investing strategy shares this approach with thecontrarian strategy .

    The link will open in a new window Learn more about the contrarian strategyat (German).

  • If you pay too much for a share, or the purchase price is too close to your determined intrinsic value, there is a risk of loss. That is why you should stick strictly to your personal safety margin.

  • The extensive research and analysis carried out by value investors often goes hand in hand with the fact that they focus only on a few companies. This creates a possible cluster risk.

  • When the stock market reacts with strong price fluctuations (e.g. due to the publication of quarterly reports or in response to other events), you must not be distracted and should continue to pursue your strategy. Provided that you still consider the company’s value to be undervalued.

  • Value investing is a long-term investment strategy. It can take a long time before any correct company value is reflected in the share price. Therefore, you should not plan to sell in the short to medium term.

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