Value investing is a popular investment strategy in which buyers seek out undervalued stocks. Value investors see this as a way to purchase profitable stocks at a ‘discounted’ price.
Value investing for 3rd graders
Consider the concept of value investing in a more accessible way.
Imagine the scene: you’re in 3rd grade, clutching your Bob the Builder lunchbox, settling into your seat at the cafeteria table next to Suzie Coleman, your one true love. You brace yourself for the daily snack trade war: your mom is on a health food kick, so whatever she’s packed probably doesn’t have much trading clout in the eyes of these pipsqueak snack sharks.
When you plop your glossy red apple onto the table, ready to give up before you start, you’re surprised to hear an angelic, “Wanna trade?” Suzie smiles, sliding a quarter towards you: just enough to buy an ice pop. Is your one true love sweet or a sucker?
From a nutritional point of view, she’s neither. Suzie is a long-term thinker. She is value investing. She saw something likely to be undervalued by the rest of the third grade “stock market,” bought it at an undervalued price, and will now reap the long-term benefits.
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In Suzie’s case, she’ll reap an-apple-a-day-keeps-the-doctor-away sort of benefits, but for value investors like Warren Buffet, this strategy can be a long-term investment strategy.
Sometimes referred to as a “buy-and-hold” strategy, value investing relies on an analysis of company fundamentals. By relying on a long-term vision of how a company will perform and grow, investors who originally purchased their holdings at a “discounted price” because of short term market fluctuations profit over time. This is an important premise of value investing.
Like any investment strategy, value investing has both advantages and disadvantages. Check out our list to learn about a few of them.
Advantages
- Value investing is like a great sale: Who doesn’t love a good sale? Value investing means you purchase stock in profitable companies at a lesser price due to fluctuations in the market.
- Long-term orientation: The long-term orientation means that the daily volatility and short-term price changes are not as important as the value of the business itself. Value investing looks at long-term profits rather than short-term losses.
- Value investing capitalizes on compounding interest: Although the dividends that you reap from your value investment may not seem that steep, reinvesting those dividends over time can exponentially grow both your investments and payouts that you get from them.
Disadvantages
- What if the “discount” drags on?: An important premise of value investing is that high-value companies are undervalued in a particular moment due to market fluctuations. It is possible that low market cap or even under performance drags on for years, and that investors don’t make as much as they initially projected.
- What if the “discount” deepens?: Just as a discount can drag on, as explained in the previous point, it can be difficult to determine when a stock has hit rock bottom. As such, it is possible that a particular stock price continues to fall after you purchase it, leading to losses before (if ever) you begin to profit over the long-term.
- Value investing requires a lot of research: The keystone relies on understanding company fundamentals to determine if they are likely to be profitable over the long haul. Like any investment skill, it will require research and study to learn how to assess company fundamentals in order to know how to value invest.
Value investing does not provide instant rewards. This strategy relies on a deep understanding of company assessments and market fluctuations.
However, if you’re a long-term, strategic thinker like Suzie Coleman, it might be a great strategy to add to your financial toolbox and diversify your investment portfolio.
