In this part . . .
Chapter 1
An Investorâs Guide to Value Investing
In This Chapter
Recognizing the value investing style â what it
is and
isnât Bottom-line value investing principles
Comparing value investing to other investing styles
Deciding if youâre a value investor
No doubt, if youâre reading Value Investing For Dummies, somewhere during your investing career you heard something about value investing. You heard about it from your retired next-door neighbor. You heard about it as âwhat Warren Buffett does.â You saw a mutual fund describe itself as a âvalue-orientedâ fund.
You have a pretty good idea what the word âvalueâ means in ordinary English. Itâs not an altogether precise concept; the Random House Dictionary of the English Language defines it as the ârelative worth, merit, or importanceâ of something. Okay, fine. But how does that apply to investing? What is value investing, anyway?
This chapter answers that question. The rest of this book gives you the background, tools, and thought processes to do it.
Definitions? No Two Are Alike
Perhaps youâve asked around â to friends, experienced investors, investing professionals â for definitions of âvalue investing.â You probably got a lot of different answers. Those answers perhaps included phrases like âconservative,â âlong-term oriented,â âthe opposite of growth,â âthe Buffett approach,â âbuying stocks with a low P/E,â âbuying stuff thatâs cheap,â or âbuying stocks that nobody wants.â
None of these is âitâ entirely, but it turns out they are all part of it.
All, except the âopposite of growth,â that is â and weâll get to that.
Value investing is an investing approach and style blending many principles of business and financial analysis to arrive at good investing decisions. This, too, is an imprecise definition, but it lays the groundwork for the more precise principles and style points that follow.
What Is Value Investing?
Toward a definition, hereâs one you may have read in the first edition of Value Investing For Dummies. It still works:
Value investing is buying shares of a business as though you were buying the business itself. Value investors emphasize the intrinsic value of assets and current and future profits, and pay a price equal to or less than that value.
Youâll quickly note key phrases: âbuying a business,â âintrinsic value,â and âpay a price equal to or less than that value.â These are explicit tenets of the value investing approach, and underlying them all is the notion of conscious appraisal â that is, the idea of a rigorous and deliberate attempt to measure business value.
Youâll also notice that âpriceâ enters the appraisal, but not until the end. Value investors only go to the stock market to buy their shares of the business. Value investors donât look at the market as an indicator of whether to invest.
With this definition of value investing as an appetizer, hereâs a âmain courseâ of value investing principles.
Buying a business
If you take nothing else away from reading this book, take away the thought process that investing in stocks is really (or should be) like buying a business.
That concept shouldnât really be that hard to grasp â after all, when you buy shares, you are buying a portion of a business, albeit in most cases a small one. This isnât to say you have to buy a larger share of the business to think of your investment as buying a business â this principle applies even if youâre buying a single share.
Put differently, whether itâs an espresso cart or 1,000 shares of Starbucks you want to buy, the purchase is analyzed the same way. Treat the investment as if you were buying the business â the whole business. By buying shares, youâre committing capital to that enterprise in exchange for an eventual healthy and appropriate return on that investment.
Now, some of you who got caught in the tech boom and bust may think you did exactly that. You followed a company and its story. The products were âkiller appsâ and everything the company did made headlines. Everybody wanted to own its products or work for the company. So you bought shares.
But did you look at business fundamentals? Intrinsic value of assets and future profit prospects? Did you understand their strategy and competitive advantages? Did you do your homework to assess whether the stock price was at or below your appraisal? Likely not. Thatâs the difference between value investing and most other forms of investing.
Making a conscious appraisal
If you were interested in buying a business for yourself and thought the corner hardware store looked attractive, how much would you be willing to pay for it? You would likely be influenced by the sale price of other hardware stores and by opinions shared by neighbors and other customers. But you would still center your attention on the int...