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Value investing might sound like a complicated strategy reserved for Wall Street pros, but it’s simpler than you think.
If you’re tired of chasing overpriced stocks and want a strategy for finding hidden gems, this post is for you.
In this post, you’ll learn:
- What value investing is and how it works
- Key metrics to look at when choosing stocks
- Risks and rewards of value investing
- How to get started today
Curious to find out how you can start uncovering undervalued stocks?
Let’s dive in!
What is value investing & how does it work?
Value investing is all about spotting a bargain in the stock market.
It’s like being at a sale where the items are priced lower than what they’re truly worth, and you’re the savvy shopper who knows the real value of what you’re buying.
The goal is to invest in stocks that are deemed “undervalued” by the market – essentially, you’re looking for companies that are trading at a price lower than their intrinsic value.
When you invest based on value, you’re betting that the market has mispriced a stock.
Why choose value investing?
Stability
One of the biggest advantages of value investing is the stability it offers, particularly during market downturns.
Unlike growth stocks, which can experience wild swings, value stocks are typically more stable because they’re already undervalued.
This means you’re not overpaying for a stock, so when the market faces turbulence, your investment is less likely to take a severe hit.
For instance, during market corrections, growth stocks tend to drop sharply as investors panic-sell, fearing their potential future earnings will not be realised.
Value stocks, on the other hand, are already priced conservatively based on their fundamentals, offering a buffer against such volatility.
Essentially, you’re lowering your risk of overpaying for a stock, which helps reduce overall volatility in your portfolio.
Higher returns
Because you’re buying stocks priced lower than their intrinsic value, you stand to gain significantly when the market eventually recognises the stock’s true worth.
The key, of course, is picking the right companies – those with strong fundamentals like steady earnings, healthy cash flow, and competent management.
In Singapore, there are plenty of opportunities to find value stocks.
Whether it’s companies temporarily overlooked by the market or firms with strong undervalued assets, the growth potential is there if you’re willing to do the research.
Over time, these stocks will likely bounce back, giving you higher returns than if you had chased overpriced growth stocks.
Long-term play
Value investing is not for the impatient.
It’s a long-term strategy that requires you to trust the fundamentals of the companies you invest in.
Because you’re focused on intrinsic value rather than market sentiment, you can ride out market volatility without getting caught up in the panic of emotional investing.
Waiting for stock to reach its fair price might take time, but that’s the beauty of value investing – it rewards patience.
While others may panic-sell during downturns, you’ll have the confidence to stay invested, knowing that the fundamentals will eventually prevail.
Approaches to value investing
Qualitative value investing
Qualitative value investing focuses on the overall quality of a company.
Rather than just looking at numbers, you evaluate factors like management effectiveness, competitive advantage, and long-term growth potential.
Think of it as digging into the company’s DNA – its leadership, its strategy, and even its industry positioning.
It involves evaluating the strength of the management team, how they’ve handled market challenges in the past, and whether the company has a unique edge over competitors that could lead to long-term growth.
Quantitative value investing
Here, you’re relying on hard data and financial ratios like price-to-earnings (P/E) and price-to-book (P/B) to determine whether a stock is undervalued.
This approach is more straightforward because it focuses on measurable metrics, making it easier to compare companies.
Quantitative value investors often look for stocks that have low ratios compared to historical trends or industry peers, with the idea that these companies are likely to perform better once the market catches up to their true value.
Employ both!
The best part? You don’t have to choose between the 2 approaches.
I use both qualitative and quantitative value investing as it gives me a complete picture of the stocks that I’m picking.
By combining data-driven analysis with a deeper understanding of the company’s core strengths, you can make better, more well-rounded investment decisions.
Using both approaches helps reduce the emotional aspect of investing.
While the numbers guide you toward undervalued stocks, the qualitative insights give you the confidence to stay invested during market fluctuations.
This balanced approach ensures that you’re not just relying on what the financials tell you but also on the company’s potential to grow over time.
The 4Ms of value investing
1. Meaning
“Meaning” refers to understanding the business you’re investing in.
It’s vital to invest in companies whose business models and industries you understand deeply.
This way, you can make informed decisions about their future performance.
When assessing a company, ask yourself the following questions:
- What does the company do? Is it a retail business, a tech company, or perhaps a manufacturer? You need to be clear about its core operations.
- How does it make money? Does it rely on a steady stream of recurring revenue, or is it dependent on one-off sales or seasonal trends? Understanding the company’s revenue model is key to predicting its growth and stability.
- What industry trends could impact its future? Every industry has its challenges and opportunities. Are there technological advancements that could disrupt the company? Or could regulatory changes benefit it? By staying aware of industry trends, you’ll be better positioned to gauge the company’s long-term potential.
2. Moat
In value investing, a company’s moat refers to its competitive advantage – the factors that protect it from competitors and help it maintain profitability over time.
The wider the moat, the better positioned a company is to sustain its competitive edge and maintain profitability.
A company’s moat can come from several sources, such as:
Brand loyalty
Think about Apple.
People pay a premium for Apple products, not just because of their quality but because of the brand’s strong emotional connection with its users.
This loyalty makes it harder for competitors to steal market share.
Patents or proprietary technology
If a company owns a unique product or process protected by patents, it creates a significant barrier for competitors.
Pharmaceutical companies are a good example, where drug patents ensure exclusive profits for years.
Cost advantages
Some companies benefit from economies of scale, meaning that as they grow, their costs per unit decrease.
For instance, a company that can produce products more cheaply than its competitors has a pricing advantage, making it difficult for others to compete.
Network effects
Companies like Facebook have a network effect, where the value of the service increases as more people use it.
The more users, the more valuable the platform becomes, making it harder for competitors to replicate that success.
Switching costs
Businesses like Adobe or Microsoft benefit from high switching costs.
Once customers are locked into their ecosystem – software, services, or specialised products – it becomes difficult and expensive to switch to a competitor.
This ensures a steady stream of revenue.
3. Management
In value investing, management determines a company’s long-term success.
Even the best business model can falter if the leadership isn’t up to the task.
You want leaders who not only have a clear strategy for growth but also the capability to execute that strategy efficiently, allocate resources wisely, and steer the company through both good and challenging times.
When evaluating a company’s management, here are some key factors to consider:
Track record
A company’s past performance often reflects its leadership’s effectiveness.
Look into the management team’s history – how have they handled previous challenges or downturns?
Have they consistently grown the business, or have there been significant missteps along the way?
Capital allocation
Good management knows how to make smart decisions with the company’s profits.
This could involve reinvesting in the business for future growth, paying out dividends to shareholders, or even buying back shares when the stock is undervalued.
If leaders are making strategic investments or efficiently managing debt, it’s a sign they are focused on long-term value creation.
Alignment of interests
It’s reassuring to know that the company’s leadership has a personal stake in its success.
When managers own shares in the company, it aligns their financial interests with those of shareholders.
This means they are likelier to make decisions that benefit long-term investors rather than chasing short-term gains.
4. Margin of safety
The margin of safety refers to purchasing a stock at a price significantly below its intrinsic value, offering you a cushion if things don’t go as planned.
Here’s how it works.
Let’s say you’ve evaluated a company and estimated its intrinsic value to be $100 per share.
If you can buy that stock for $70, you’ve built a margin of safety of 30%.
This means even if the company’s performance doesn’t fully live up to expectations or if the broader market faces volatility, your risk of losing money is lower.
It provides you with room for error in your analysis.
What are some key metrics I should look at when value investing?
Price-to-earnings (P/E) and price-to-earnings growth (PEG) ratios
The P/E ratio compares a company’s stock price to its earnings per share, giving you a quick way to assess if a stock is undervalued relative to its earnings.
A lower P/E ratio than industry averages or competitors can suggest the stock is undervalued.
However, it’s crucial not to stop at the P/E ratio alone.
This is where the PEG ratio comes in.
The PEG ratio adjusts the P/E by factoring in the company’s expected earnings growth.
Ideally, a PEG ratio of below 1 is considered a sign of value because it means you’re not just buying a cheap stock but also one with strong growth potential.
Price-to-book (P/B) ratio
The P/B ratio compares a company’s stock price to its book value, essentially its assets minus liabilities.
This ratio helps you see how much you’re paying for a company’s assets on a per-share basis.
A P/B ratio below 1 can indicate that the stock is undervalued, particularly in capital-intensive industries, like real estate or manufacturing.
This is a strong indicator of a potential bargain, especially when the company’s balance sheet shows valuable assets, but the stock market hasn’t caught on yet.
Free cash flow (FCF)
Free cash flow (FCF) is a critical metric that shows the cash a company has left after covering its capital expenditures (such as maintenance, equipment, or property investments).
A positive and growing FCF shows a company’s robust financial health.
It means the business can fund its operations without relying on external financing, pay dividends to shareholders, reduce its debt, or reinvest for future growth.
Return on equity (ROE)
Return on equity (ROE) measures how well a company uses shareholders’ equity to generate profit.
In simple terms, it tells you how effectively management is using the money invested by shareholders to grow the business.
A higher ROE signals that the company is efficiently managing its resources and delivering value back to investors.
Margin of safety (Intrinsic value vs. Stock price)
The margin of safety is the difference between a company’s intrinsic value and its current stock price, giving you a buffer against market volatility.
To estimate intrinsic value, investors often use valuation models such as Discounted Cash Flow (DCF) analysis, which calculates the present value of future cash flows.
For example, if your DCF analysis estimates a company’s intrinsic value at $50 per share, but the current stock price is $35, you’ve got a margin of safety of $15.
This means you have a cushion if your estimates are off or the market faces turbulence.
Investing at a price significantly below intrinsic value minimises the risk of losses while giving your investment room to grow as the market corrects its pricing.
What are some risks to value investing?
Research intensive
Finding undervalued stocks takes time, effort, and a certain level of skill.
You need to deeply analyse financial reports, balance sheets, and industry trends to determine a company’s intrinsic value accurately.
This isn’t something you can do casually – it requires a commitment to learning and staying updated on market changes.
If you’re not prepared to put in the research, you might miss critical factors that could affect the stock’s future performance.
Ratio analysis flaws
While ratios like P/E are popular tools for identifying undervalued stocks, they can sometimes be misleading or difficult to interpret.
P/E ratios, for instance, can vary significantly across industries, making direct comparisons tricky.
A low P/E might seem like a good deal, but it could also signal deeper issues with the company, such as declining earnings or a lack of future growth prospects.
Additionally, changes in earnings due to one-off events or accounting adjustments can skew these ratios, complicating your analysis.
Relying too heavily on ratio analysis without considering the broader context can lead you to invest in companies that are “cheap for a reason.”
Uncertainty
External factors, such as economic downturns, changes in regulations, or shifts in industry trends, can impact a company’s fundamentals, often in ways that are hard to predict.
Even if you’ve thoroughly researched a stock and believe it’s undervalued, unforeseen events can drastically alter its prospects.
For instance, a Singaporean company may be hit by regulatory changes that negatively affect its industry, or a global event like the COVID-19 pandemic can disrupt entire markets.
These external forces can change a company’s fundamentals overnight, making it harder to achieve the returns you anticipated.
Patience required
Patience is a cornerstone of value investing, but it can also be a drawback for some.
When you invest in undervalued stocks, it often takes time for the market to recognise their true value.
You may need to hold onto your stocks for several years before seeing significant returns.
During this time, market volatility can test your resolve.
It’s not uncommon for value stocks to experience dips or stagnate while you wait for the market to correct its pricing.
If you’re not prepared to play the long game, you might get frustrated and sell prematurely, missing out on the potential for long-term gains.
Self-confidence needed
Since you’re often investing in stocks that others may be avoiding or undervaluing, you need to trust your research and judgement.
This can be stressful, especially when the market or other investors don’t immediately agree with your assessment.
You might hold onto a stock for months or even years while others move in different directions.
During these times, it’s easy to second-guess your decisions.
Staying confident in your analysis is crucial, but it can be mentally challenging when the broader market isn’t validating your view.
Weak diversification
Because value investors often focus on sectors or industries that are currently underperforming, it can lead to a portfolio that is concentrated in troubled areas.
For example, if you’re investing heavily in a declining industry because of undervalued stocks, you could face significant risks if that sector doesn’t recover as expected.
This lack of diversification can increase exposure to sector-specific risks.
A well-rounded portfolio should spread risk across various industries.
Still, value investing can sometimes steer you toward concentrated bets in specific sectors, limiting your protection from broader market shifts.
While focusing on undervalued opportunities is key, it’s also essential to maintain a balanced approach, ensuring that your portfolio isn’t overly exposed to one area, especially if that sector struggles to recover.
How do I minimise these risks?
Follow the 4Ms
To succeed in value investing, sticking to the 4Ms – Meaning, Moat, Management, and Margin of Safety – is essential.
These pillars help ensure that you’re not just buying a stock because it’s cheap but backed by solid fundamentals.
This strategy keeps you grounded in data and analysis, rather than market sentiment, reducing the chances of emotional or impulsive decisions.
Have a contrarian mindset
This means being willing to buy stocks others sell, even when it feels uncomfortable.
It’s about going against the crowd and recognising opportunities where the market sees problems.
Often, the best value opportunities come from stocks that are overlooked, underappreciated, or even discarded by the broader market.
While it might feel counterintuitive, especially when everyone else seems to avoid certain stocks, this approach often leads to finding hidden gems.
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One of the strategies I use to succeed as a value investor is relying on a stock screener that helps me identify undervalued stocks, avoid overpriced ones, and focus on opportunities with strong fundamentals.
This approach ensures that every stock I invest in aligns with core principles like having a clear purpose (meaning), a competitive advantage (moat), competent management, and a margin of safety (MOS) to protect my investment.
Thanks to this disciplined method, I’ve already seen a 50% return since the start of 2024 – even during market dips.
It’s not always easy to stay the course, especially when the market moves unpredictably, but trusting the data and sticking to my analysis has paid off.
Every Sunday, I share 3 to 5 undervalued stocks in my Sunday Stock Day email series – for free.
These picks save you time by cutting through the noise and focusing on stocks with strong fundamentals and long-term potential.
Each stock is carefully selected to align with value investing principles, helping you avoid overpriced hype and stay grounded in solid opportunities.
You’ll also get updates on market trends to stay ahead without spending hours researching.
If you want all these for free, sign up for my email list.
Who is value investing for?
Long-term investors
Value investing is ideal for individuals with a long-term investment horizon.
If you’re someone who’s in no rush to make quick profits and is comfortable holding onto stocks for years, this strategy suits you well.
Value investing rewards patience, allowing you to ride out market fluctuations while waiting for your undervalued stocks to reach their full potential.
For example, if you’re planning for retirement and are focused on building wealth gradually, value investing allows you to grow your portfolio steadily over time.
Conservative investors
For those who prefer a lower-risk approach to investing, value investing provides a more conservative path than speculative strategies.
Since the focus is on buying undervalued stocks at a discount, you reduce the risk of overpaying for an asset.
Additionally, value stocks tend to be more stable, offering a buffer against market volatility.
Income-focused investors
Value investing also appeals to dividend-seeking investors.
Many undervalued stocks, particularly in sectors like utilities, real estate, and financials, tend to be dividend-paying companies.
These companies are often mature businesses with steady cash flow, allowing them to reward shareholders through regular dividend payments.
For individuals looking for passive income, such as retirees or those seeking financial independence, value investing can provide a reliable stream of dividends while offering potential long-term capital appreciation as the stock price eventually rises.
Contrarian investors
If you enjoy going against the grain and aren’t afraid to invest in stocks others might be avoiding, value investing is perfect for the contrarian investor.
You thrive on finding opportunities where the market is overly pessimistic and uncovering stocks that have been overlooked or discarded by others.
For contrarians, value investing offers the chance to buy solid companies at bargain prices, positioning themselves for significant gains when the market eventually corrects.
Frequently asked questions
Why should I learn value investing?
You should learn value investing because it’s a proven strategy focusing on finding undervalued stocks with strong fundamentals.
By understanding value investing, you can make smarter, data-driven decisions and avoid overpaying for stocks, which can reduce your investment risk.
Additionally, value investing encourages patience and long-term thinking, which can lead to greater returns over time.
How do I get started in value investing?
To get started in value investing, you should first focus on building a solid understanding of financial metrics like the price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and free cash flow (FCF).
Begin by researching companies with strong fundamentals, and use tools like stock screeners to help identify undervalued stocks.
Start with smaller investments to familiarise yourself with the process, and ensure you stay patient.
Conclusion
In this post, we’ve broken down the essentials of value investing, covering everything from the 4Ms (meaning, moat, management, and margin of safety) to the key metrics you should look at when picking stocks.
We also discussed why value investing might be right for you, some risks involved, and how having a contrarian mindset can give you an edge.
Value investing requires patience, research, and a long-term perspective, but when done right, it can lead to significant rewards.
If you’re unsure or need help getting started, don’t worry – you don’t have to do it alone!
Feel free to reach out and talk to one of our financial advisor partners for free.
They’re here to help you make informed decisions and guide you through the value investing journey.
