Understanding Value investing in India: There are many successful investment strategies in the stock market. Three of such popular investing strategies are- Value investing, growth investing, and dividend investing. It’s really difficult to say which one is better as it totally depends on the investor’s preference, style, and knowledge.
Nevertheless, value investing is one such proven strategy that has created huge wealth for many investors over the years who have followed this strategy with discipline. In fact, one of the biggest followers and advocates of value investing is the legendary investor, Warren Buffett.
“Price is what you pay. Value is what you get.” -Warren Buffett
In this post, we are going to discuss the principles of value investing. It’s going to be a captivating post for long-term investors who are trying to understand the concept of value investing in India. Therefore, without wasting any further time, let’s understand the concept of value investing in India.
What is value investing?
The basic strategy of value investing is very simple. You find an amazing company, calculate its true value (also known as Intrinsic value) and pay a lot less to purchase the stock (when the market is down or when the stock is on sale in the market). As you have bought the stock at a discount, you can make a profit by selling the stock when the price reaches its true value.
For example, if the true value of a share (as per your calculations) is Rs 200, however, it is currently trading at Rs 120. Then the stock is undervalued. Value investing strategy educates investing in such stocks that are trading way below their true value or are undervalued. Here, you’ve to wait for their prices to appreciate and reach their actual intrinsic value to make profits.
A few common approaches that value investors use for stock valuation (or its intrinsic value) are Relative and Absolute Valuation. In order to find undervalued stocks using the relative valuation, financial tools like lower than average price to book value, a low PE ratio, or higher dividend yields are used. On the other hand, you can also use absolute valuation techniques like Discounted Cashflow (DCF), Dividend Discount Model (DDM), etc to find out the true value of stocks.
Quick Note: We’ve already covered important financial ratios and valuation methods like relative valuation, DDM etc in my earlier posts. Further, if you want to learn different valuation tools (like DCF, ROE valuation etc), feel free to check out our online course: ‘HOW TO PICK WINNING STOCKS?’
A brief history of value investing:
“It is much better to buy a wonderful company at a fair price than a fair company at a wonderful price.” -Benjamin Graham
Although value investing is a very old strategy of investing in stocks, however more than anyone else, Benjamin Graham is credited for popularising this concept. Graham developed the value investing philosophy after surviving the great depression of 1929-30s, when the Dow lost an unbelievable 89% over a three-year span.
Graham was the professor of finance at Columbia business school and authored the book ‘The Intelligent Investor’ in 1947. Coincidently, Benjamin Graham was also the mentor of the Billionaire Investor “Warren Buffett“. After inheriting the concept of Value Investing from Graham, Buffett further popularised it among the investing population.
Here’s a snippet of Value investing Strategy from the book “The Intelligent Investor” by Benjamin Graham:
(Image: A snippet from Ben Graham’s book – The Intelligent Investor)
Like Graham, Warren Buffett also looks for undervalued companies that are steady cash flows driven, alongside a straightforward business model. Buffett’s company- “Berkshire Hathaway” has generated an average annual return of above 22% for more than 50 years using Value investing strategies, making Buffett one of the richest people in this world.
Three Fundamental philosophies of Value investing
Value investors believe that the market overreacts to good and bad news and hence they do not correspond with the company’s long-term fundamentals. Therefore, at a specific time in the market, stocks can be overvalued, undervalued or decently valued.
The strategy of value investing is to find the undervalued stocks -which are trading at a discount because of short-term reasons or market not yet realizing their true potential. Here are the three fundamental philosophies of value investing:
1. Look for the True/Intrinsic Value
What distingue value investing from other popular strategies is that value investors believe that stocks have an intrinsic or true value. They find this concrete number using different valuation methods like discounted cash flow analysis. When the market value of that stock is below the calculated value, the value investors purchase that stock. Further, as these investors have bought the stock at a discount, they sit back and relax until the stock reaches its true value.
Quick Note: Value investors do not believe in the Efficient Market Hypothesis (EMH).
2. Avoid following the Herd
“Be greedy when others are fearful and be fearful when the other’s are greedy.” -Warren Buffett
Interestingly, you can find a large population of investing community following herd mentality psychology in making various financial decisions like buying a new property or investing in the stock market. Seeing others getting profited with investment, our brain tells us to go for it without a second thought.
However, the value investors avoid the herd mentality. They do not believe in group thinking or buying a stock just because everyone else is buying. That’s why, many a time- the value investing strategies looks similar to contrarian investing.
3. Always have a “Margin of Safety”
The margin of safety is the guiding philosophy of value investing to reduce risk and avoid loss. Here, the value investor gives a benefit of doubt to themselves by purchasing a stock with a margin of safety.
For example, let’s assume that an investor calculated the true value of a company to be Rs 100. Here, buying the stock at any price below Rs 100 can be considered as an undervalued price. However, if the investor wants a margin of safety of 20%, then he/she will buy that stock at Rs 80 or less. Here, the value investor is safeguarding his investment by adding a significant margin of safety in his/her purchase price.
Does value investing in India works?
Tell me one thing- If I offer you to purchase the stock of a good business at a discount of 50% on its share price- Isn’t this a good deal profitable to you? You can sell it for a price way higher than your original purchase price in the future. Even if you’re not planning to sell it, you’ll be happy that you’ve bought the shares of an amazing company at a great discount. You can keep that stock in your portfolio confidently.
Value investing works on the same concept everywhere. Here, you buy superb stocks at a price below their intrinsic value (i.e. discount price) and hold it till they reach their true value.
So, does value investing in India works? Absolutely!! Value investing is a time-tested strategy. From Benjamin Graham to Warren Buffett to Joel Greenblatt to Raamdeo Agrawal -all these super investors have made a massive fortune by following the strategies of value investing.
Best books to learn value investing in India
I tried to cover most of the critical points related to value investing in India in this post. However, there are still many concepts yet to learn for beginners. Here are the best books to learn about value investing in India. (Note that few of the books mentioned below are written by foreign authors, but the concepts are applicable everywhere)-
- The Intelligent Investor by Benjamin Graham
- Value Investing and behavioral finance by Parag Parikh
- The Little Book of Value Investing by Christopher H. Browne
- The Warren Buffett Way by Robert G. Hagstrom
- The Little Book That Beats the Market by Joel Greenblatt
Value investing is a proven strategy to build wealth. And value investing in India definitely works for those who apply this strategy with discipline. However, the exact definition of value investing is subjective and depends on the investor’s style of investing.
While many value investors only look for undervalued stocks, few also consider the growth, future earnings expectations, and cash flows to determine the future value. For example, the star fund manager Peter Lynch (Author of One up on wall street) was more interested in undervalued stocks with good growth prospects. That’s why he preferred PEG ratio over PE ratio. Such kinds of stocks are called GARP (Growth at Reasonable Price) stocks.
Whatever the approach- the underlying principle of value investing is the same– find an amazing company and pay less than what it’s true worth with a significant margin of safety. That’s all for this post on Value investing in India. I hope it was useful to you. Have a great day and Happy Investing.
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