There are various proven ways to make money in the stock market, but only a select few guarantee long-term profits. For those that do, most of their market-beating strategies have their roots in value investing. And although their profitability levels differ, all produce remarkable results.
Value investing beats the market though not always. Like any other investment strategy, value investing underperforms at one time or the other, and you end up losing money. But in the long term, the strategy can outperform the market, handsomely rewarding those who stick with it.
In this article, we will discuss what value investing is, what it entails, and how you can do it successfully.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Is Value Investing?
Value investing is a type of investment strategy whereby a trader selects undervalued stocks from solid companies—those that look like they’re selling for a lot less than their intrinsic value.
So, value investors specialize in identifying and buying the stocks they think the rest of the market is currently overlooking or underestimating. They then hold on to these value stocks for long, getting handsomely rewarded for the same.
Savvy value investors like Warren Buffett reckon that the stock market tends to overreact to both positive and negative news. This behavior results in price movements that have no relation to a given company’s long-term fundamentals. However, the overreaction provides the perfect opportunity to make a profit by purchasing the stocks at massively discounted prices.
As such, value investors do not follow a herd mentality when investing. Instead, they focus on financial analysis to select companies and then invest in them for the long-term.
6 Things You Must Know To Be Successful With Value Investing
Value Investing Does Not Always Yield Uniform Results
Your value investing strategy will not yield the same returns year in, year out. So, no matter how promising your strategy seems, sometimes it will underperform the market, and you will lose money. This is when you need to focus on your long-term goals and stay put.
Unfortunately, most investors bail out when their strategy starts to underperform. This is because they focus on short-term gains and usually jump on to the next best-performing stock.
To win at value investing, you need to avoid chasing returns and learn how the market works. Besides, by opting to stick to a well-chosen value investment strategy, you have a higher likelihood of getting returns equal to the value of your investment strategy.
You Need To Set Your Margin of Safety
It’s essential to allow room for error when estimating value hence the need to set your margin of safety before purchasing stocks. Ideally, you should set this margin based on your risk tolerance.
All investments have some level of risk. So, it pays to learn about risk management techniques even if you intend to hold your stock for a long time and ignore market fluctuations. Sometimes, companies go belly up and their investors lose all their money.
Having a margin of safety presents you with a better opportunity to make a profit when you eventually sell them. It also reduces your chances of making losses if the stock fails to perform as per your expectations.
Remember That Markets Are Not Always Efficient
Value investors don’t buy into the widely-held notion that stock prices take all relevant company info into account, so their price always reflects this value. Instead, they understand that stock prices could be higher or lower than their book value due to several factors. Some of these factors could be economic, political, or even psychological.
You Need Consistency and Patience
The intrinsic value of a stock is not so easy to establish since it entails financial analysis and subjectivity.
For instance, two investors can analyze a stock using the same valuation criteria but come up with varying estimates. One might focus solely on current financials, while the other might also consider estimating a company’s future growth.
As a result, you need to be consistent and have the patience to stick to your investment goals. This means that while you may want to buy certain stocks bearing the right fundamentals, at times, they could be overpriced. Thus, you may have to wait, purchase other stocks with more attractive prices, or await the next opportunity.
Set Your Eyes on Dividend Paying Companies
Intelligent value investors look beyond a company’s short-term earnings focusing instead on those that pay dividends consistently. This is because such companies usually pay part of their profits to their investors (shareholders) as dividends. They are often mature and highly profitable.
Following the Herd Is a Bad Idea
When you buy a company’s stocks, you own a percentage of that company. And since a value investor’s sole interest in a given stock is its intrinsic value, their goal is to own companies with strong principles and financials despite what the rest of the market is doing.
Therefore, guided by their own fundamental analysis, value investors either sell when others are buying or stand back and watch.
In contrast, when all the other traders are selling, they buy or hold. In addition, they refrain from buying trendy but overpriced stocks and choose to invest in unknown companies with sound financials.
On the same note, value investors consider buying common stocks when their prices plummet. They base their thinking on the belief that if the companies provide quality products and their fundamentals remain solid, they can bounce back from any setbacks.
How to Beat the Market With Value Investing?
In order to succeed at beating the market and make significant returns from your investments, the first thing to do is choose the right strategy, such as value investing. Then look at how the strategy has performed over the years as a basis for predicting your expected returns. This will also inform you how often you should expect it to underperform.
Once you choose your strategy, stick with it through and through. Do not abandon it when it starts underperforming the market.
The following are additional approaches that will help you get the most out of value investing:
- Perform an in-depth analysis of your select stocks and the companies behind them before investing. This will ensure you get steady returns. Some of the things you need to look into include a company’s business principles, long-term plans, financial structure, and management team.
- Learn the specific actions you need to take to optimize your value investing. You can also do this by seeking assistance from investors who have made impressive earnings through value investing.
- Go for consistency. Safe but steady returns beat profits from one-time hot stocks. Choose low-risk stocks that will bring in consistent returns year after year.
- Diversify your portfolio. It’s advisable to have other types of investments – alongside value investing. This can protect your investments from serious losses. While there’s proof that value investing offers steady returns, nothing is guaranteed when it comes to investing; hence having a diversified portfolio reduces your risk exposure.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
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Conclusion
While different investors use different approaches, the overall aim of value investing is to:
- Buy assets for less money than they are worth.
- Hold onto the assets for the long term.
- Sell them off at a price that matches their intrinsic value or more.
Value investing does not bring instant gratification. To beat the market, you have to be ready to wait for many years until your investments pay off. You also have to be prepared to lose money occasionally.
Fortunately, long-term capital gains attract a much lower tax rate than gains from short-term investment, thereby earning you much more.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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