There are many ways to make money in the stock market. The
most commonly cited approaches are value investing, growth
investing, and day trading. There are many arguments for and
against each of these investing styles, but value investing is
probably the most
one for making money in the stock market over the long haul.
What is value investing?
In its most basic form, value investing consists of buying
stocks at a discount to an estimation of intrinsic value in hopes
that the market will eventually recognize the underlying worth of
the business. What is intrinsic value? It's simply an estimate of
a company's true worth.
In one chart, value investing may look something like
Graphic by Daniel Sparks.
While most value investors agree that the approach constitutes
buying a stock only when it trades at a discount to fair value,
offering a margin of safety, there is less consensus among value
investors on when to sell. Not only does selling have tax
implications, but it can also mean selling the best-performing
company in a portfolio -- not necessarily the best performer as a
, but the best performer as a
So some value investors opt for alternatives to simply selling
stocks as soon as they become overvalued. These alternatives are
usually to sell a stock only if 1) it appears
overvalued or 2) the underlying business fails to meet or exceed
What is the history of value investing?
Benjamin Graham was the mentor to the world's greatest
investor, Warren Buffett. And Graham is often referred to as the
father of value investing.
While Graham certainly didn't popularize the term
, he did identify the core principles of the philosophy --
particularly the idea of a margin of safety and intrinsic
Buffett, now among the world's richest men, added an important
criterion to value investing that begins to blur the lines
between value investing and growth investing. Investments,
Buffett says, should have an economic moat -- that is, a durable
competitive advantage. That factor is probably the most recent
major evolution in this approach to investing.
"In business, I look for economic castles protected by
unbreachable moats," Buffett has said. The wider the moat, he
argues, the more sustainable the business.
But the more sustainable the business, the more investors will
need to rely on future estimations of cash flow. And once value
investors begin attributing a significant portion of an asset's
potential, investors will start to lean toward a growth investing
Perhaps this is why Buffett concluded in his 1992 annual
shareholders that "the two approaches are joined at the hip."
How many value investing approaches are there?
Value investing is best viewed on a spectrum, with
conservatism at one end and growth at the other. While both ends
of the spectrum require businesses to have an economic moat, ones
at the growth end require investors to rely heavily on growth
projections. And ones at the conservative end aren't growing
quickly and often make estimating intrinsic value an easier
There are value investors who prefer slower-growing businesses
with a substantial track record, so that they can feel
comfortable about their estimation of intrinsic value (and
hopefully reduce risk), and there are value investors who go for
faster-growing companies and closely observe the qualitative
factors that could preserve higher growth rates. Both are value
investors, just on different ends of the spectrum.
What is the advantage of value investing?
These are the most significant advantages to value
- Portfolio turnover is low (and, thus, portfolio maintenance
- Having a margin of safety means investors can win even when
they were too aggressive in their fair-value estimate.
- Investors don't have to watch the market very often, since
intrinsic value estimations aren't going to change very
As with most forms of investing, it's important to remember
that it is an art, not a science; there are no hard-and-fast
rules to value investing.
But if you decide value investing is for you, keep these three
concepts in mind. Margin of safety, intrinsic value, and economic
moat are the pillars of the value investing approach.
Value: Investing Essentials
originally appeared on Fool.com.
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