|Market theory states that investors in shares get paid for risking their money. The greater the risk we take, the larger the payment. Therefore, in the grand scheme of things, risk equals profit. Like all theories, this is bound by a number of basic principles that, when examined, open up a lot of room for other opportunities. |
Value investing is far from risky. Many would see it as the most conservative way possible to invest your money, and very risk averse indeed. In fact, some consider it to be the most boring type of investing. Even so, over the years, value investing has been a very rewarding way to profit in the market.
WHO DOESN'T LIKE A BARGAIN?
While the underlying system has changed over time, value investing still remains the art of picking cheap stocks. In the early days, it was as simple as picking low price/earnings ratio, high-yield, asset-rich companies, then sitting back until they rallied, but such obvious picks have become rarer. However, they have not disappeared altogether.
It makes perfect sense that risk equals reward when you consider the motivation of investing. The more likely you are to get burned on a deal, the more payout you want. The gamble pays off if disaster doesn't strike. The law of supply and demand does the rest, and the result is the more dangerous a set of risks, the more payout you will receive.
This is one of the reasons you have a portfolio; spreading risk over different investments enables winning and losing investments to average out painlessly. By spreading the risk, you can benefit from the reward. Further, reward comes in many forms and people are often paid in kind. For many, payment comes in the form of pleasure: the glamour and excitement of an investment. If you're thrilled by a stock because it has a great brand or an enthralling story to tell, you will pay through the nose for it. It is not surprising that there is a chance that glamour stocks will result in smaller returns since you are paying a premium for them.
It has long been known that investing in value stocks brings a solid return above the index. Discovered by Benjamin Graham in the 1950s and perfected by a student of his, Warren Buffett, value stocks are a great way to get rich slowly by investing cautiously over the long term. Sadly, the "get rich slow" element doesn't suit many. Investors are natural bulls, driven by optimism. More often than not, people go hunting for massive returns instead of a little outperformance. Consequently, most of them end up getting poor quick, rather than rich slow.
THE OTHER CAMP
There are many investment tactics. For example, momentum investing was the toast of the late 1990s. The idea was to jump on a fast-moving stock and ride with it. Clearly, a momentum stock was going up, so the idea was to jump on the trend. The extreme form of this tactic was the "greater fool" plan, where a momentum investor simply had to sell his stock to someone more stupid than himself to make a profit.
Momentum investing is very tempting. There is often a new craze in the market in which a type of stock skyrockets. When that happens, it is hard to control the greed impulse that would sweep you up in the herd euphoria. As a result, you may find yourself jumping into the stock toward the end of the rally. This is one of the flaws to momentum investing. Another is that you really have no idea why you're investing at all, except that everyone else is. And while it's reasonable to expect to be paid to risk your money, the wages of not doing your homework are notoriously disastrous.
Most people indulge in random investing, which can actually be quite close to the buy-and-hold model. Buy-and-hold tends to suggest you can't outperform the market, and so long as you hold a broad basket of stocks, you may as well sit back and go along for the ride. This is certainly a low-stress way of doing things — so long as you spread your risks around. But then again, an active investor is trying to do better.
Value investing comes down to investing in companies whose stocks are considered cheap or "unfashionable." If we pay a premium for exciting, glamorous stocks, we will pay a discount for unfashionable ones. Of course, it's hard to measure "unfashionable," but you can track down these stocks online in two ways. On the Internet, you can access a wealth of data on companies and use powerful tools to sift through mountains of data. These companies have low P/Es, high dividends, a large multiple of sales to market cap, and generally have had falling stock prices for long periods. The chart will look comatose and have a stagnant price.
The classic chart of a value stock looks like a mountain terrain. You will see that the long-term price of a classic value stock has shot down a steep slope, and is now bobbing along the hills going nowhere in particular, except maybe slightly down.
While similar companies in the same sector doing the same job will enjoy higher P/Es and have lower multiple of sales to market cap, there will be no apparent reason why the cheap company is valued at a rating significantly lower than its more fashionable competitors. Spending a few hours on the Internet will establish if there is anything very wrong with the company, and most times there will not be.
Even though value investment companies may not be providing trendy services on the Internet, you'll discover from their balance sheets that they have piles of assets, cash building up in the bank that can't be hidden, and a big ratio of sales to market cap. These are all signs a company is on the cheap.
Another way to find value investments is to search the investment message boards, such as those at www.advfn.com. Don't look for a fantastically busy topic; instead, look for small, factual references to companies that fit the bill, and do your own follow-up research. If no one is talking too much about a stock, it's worth looking into, as the price is almost bound to move when the searchlight of Internet interest is turned on it.
The most important thing is to do your own research into companies you plan to invest in. Whatever tack you take in investing, one piece of your own research is worth 10 tips. The key to value investments is finding solid businesses at a low valuation. There are 20,000 stocks listed on the US exchanges, far too many to get much coverage in the media or from analysts. This gives the private investor the opportunity to go prospecting.
Just for a quick look, here are some value stocks to peruse: Ford Motor Co. (F); General Motors Corp. (GM); Village Super Market A (VLGEA); Magna International (MGA); Ingles Markets (IMKTE); Grupo Casa Saba SA (SAB); and Lear Corp. (LEA).
You could look forward to finding ways to spend your money.
Clem Chambers is CEO of ADVFN, a stocks and shares website.
Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.