Why Value Investing?
Is Value Investing the best way to invest in businesses? Why Value Investing, as opposed to other methods?
There are many ways to invest in businesses through buying shares. On this page I explore some of the options and point out where I believe Value Investing has the edge.
Trading vs Value Investing
On the Value Investing page it pointed out how the market price for shares can bounce around, going up and down due to various influences. As Charles S. Mizrahi points out in his excellent book, Getting Started in Value Investing, the stock market isn’t efficient (contrary to Efficient Market Theory) due to the key influence of human emotion. People hate losing, so sell when the prices are dropping, and hate to see others winning, so jump in and buy when the prices are rising.
Share Traders try to capitalise on these short-term movements in share prices. Similar to forex (foreign exchange) trading, traders try to judge the tide of the market and estimate the movement in share prices. They buy and sell according to market news and technical indicators. The type and quality of the underlying business often has little bearing on the attractiveness of the ‘trade’.
In comparison, while you use the highs and lows of the market to create buying opportunities, the underlying goal in Value Investing is to buy shares in a great business and stick with that business while it grows and creates you with wealth. Value Investors do not try to ‘time the market’. Value Investing is about well considered business investment decisions and ignoring the noise that surrounds the market.
'Buy and Hold' vs Value Investing
The 'Buy and Hold' method is a long-term investment strategy. One where you buy shares in businesses and hold them for several years. The theory being that all businesses will grow over time and the share market will follow. Sounds similar to Value Investing doesn’t it?
Value Investing can be used as part of a buy and hold strategy, however it can be used for shorter term strategies as well. Where Value Investing has its advantage is that you buy the business at value or at a discount. A Buy and Hold investor could end up buying shares at a premium and thus miss out on short to medium term gain. For example, if a Buy and Hold investor buys shares in a business at a 10% premium then they need the value of the business to grow by 20% to make a gain of 10% (i.e. the share price will likely ‘revert to norm’ and drop by 10% and then will need to rise by 20% to reach 10% more than the investor paid). Whereas, a Value Investor may buy at a 10% discount on the business's value, so will gain by 30% when the value reverts to norm and then grows by 20%.
A Buy and Hold strategy uses passive portfolio management. Value Investors may also use passive portfolio management - i.e. buy at a discount to value, but then hold for the long term. Alternatively, Value Investors can use active portfolio management, supported by various strategies to increase investment returns (e.g. buy at a discount to value, but sell when the market price is overvalued by a certain amount and there is a better alternative investment that can be purchased at good value).
Dividend investing vs Value Investing
Dividend investing, also known as ‘yield investing’, is where the investor is investing to gain income from dividends and is not relying on capital gain for their return on investment. In Value Investing we are concerned with capital protection. While chasing yield there is a risk that the dividend investor’s invested capital can be eroded. The business may be paying out a good amount in dividends, but meanwhile the business’s share price is declining - especially if the investor paid a premium for the shares at the outset!
Why use Value Investing as a dividend investor? Value Investing is a great method to employ for both growth and income (dividend) investing. It complements an income strategy by ensuring shares in the business are purchased at fair value and that the dividend returns are paid out without detriment to the business's long-term value. By buying at, or below, fair value there is less chance that your invested capital will be eroded by a reduction in share price.
So why use Value Investing?
Value Investing gives you an edge. It gives you a higher level of confidence in your investment decisions. It is adaptable to suit your investment strategies and will help you reach your investment goals.
Want to find out how to Value Invest? Please see our How to Value Invest page for some introductory information on how you can use Value Investing right now!