“It is only in a bear market that the value investing discipline becomes especially important because value investing, virtually alone among strategies, gives you exposure to the upside with limited downside risk.” Seth Klarman
Value stocks have historically been considered one of the most successful ways to invest for long-term investors in the equity markets. Value investing is a long-term investment strategy whose basic concept is to identify stocks that represent bargains or whom stock price are deemed cheap, and hold the stock decades. This is usually because such companies are out-of-favor with the consensus investors.
Stocks are considered to be undervalued based on several metrics. Those metrics can include a price-to-earnings ratio lower than their industry-standard, below average price-to-book ratio, or an above average dividend yield.
Value investing, according to investing guru Benjamin Graham, involved seeking stocks that were selling at an extraordinary discount to the value of the underlying assets, which he called the “intrinsic value”.
Billionaire investor Warren Buffett embraced the value investing concept, but took it a step further. Unlike Graham, he wanted to look beyond the numbers and focus on the company’s management team and its product’s competitive advantage in the marketplace.
Two essential principles behind value investing over the long-term, meaning decades, are:
- If you buy a stock for less than it’s true worth, the stock’s price will eventually converge with it’s intrinsic value; and
- If you buy a wonderful business, the value of that business will compound and increase exponentially the longer you hold on to it.
The most important thing to understand is that value investing requires a long-term mindset. Renowned economist John Maynard Keynes once said, “The market can remain irrational longer than you can remain solvent.” The lesson is that while occasionally one’s timing is fortunate and an investment pays off very quickly, even a value-focused strategy doesn’t guarantee quick gains.
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.” Ben Graham
Mr. Market doesn’t always “realize” very quickly that it was wrong about a stock or that it undervalued an asset. But, over the long-term, Mr, Market tends to abide by a company’s fundamentals such as earnings growth.
For most retail investors, stocks, from the truly long-term 30-year perspective, are safer than bonds.
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