What is value investing in the stock market and how it works

Value investing is a investment strategy in which investors buy stocks that is trading at a price lower than the estimated intrinsic value.  This means investors will look for stocks which are trading below their true worth. Investors following this principle are known as value investors.

As per this principle, investing in stock is based on finding what it is worth (intrinsic value) and what is the margin of safety in investing.

By calculating the intrinsic value of a stock you can answer the following two questions:

  • Is the stock available at a bargain price compared to the amount the buyers of the entire company would pay, and
  • Is the stock overvalued

Investors continuously look for stocks that they believe are undervalued by the market or available at a bargain price but have tremendous potential of upside.

Value investing can point you in the direction of good stocks that the market has undervalued.

Investors calculate intrinsic value based on the long-term fundamentals of the company and then compare it to the present market price to know the margin of safety. In case of high margin of safety, investors buy the stock and sell it when the valuation is high compared to its intrinsic value.

Investors don’t believe in the efficient market hypothesis, which states that stock prices fully reflect all available information due to which it’s impossible to beat the market. In other words efficient market theory claims there is no rich or cheap stock in the market as stocks are perfectly priced based on the known information.

On the contrary, Investors always believe that the price of a stock can be overvalued or undervalued based on so many factors. They are concerned with the business and its fundamentals. If fundamentals are sound, but the price is below its true worth, the stock is a good investment candidate.

Fundamentals such as earnings growth, dividends, price to earnings P/E ratio, PEG ratio, debt to equity ratio, cash flow and P/B ratio are the most important factor to know how strong the company is and what is its intrinsic value.

In simpler words, value investing is purchasing stock for less than they are currently worth, hold them for long-term, and sell for profit when they return to the intrinsic value or above. Here are the ten well known investors of the world:

  • Benjamin Graham
  • Warren buffet
  • Charlie Munger
  • Christopher Browne
  • Seth Klarman
  • David Dodd
  • Peter Lynch
  • Ray Dalio
  • Joel Greenblatt
  • Whitney Tilson