Perhaps the biggest question we are faced with today is how to get into stocks. We often hear this question several times a day because people, like you and me, are interested in investing because we know that we cannot rely on Social Security as our form of income once we retire.
You and I both know that if we wish to live a comfortable life after we are done working, we need to take matters into our own hands, which is where investing comes in.
Value investing is just one of the approaches that new investors, like you, can use to get started in investing.
In this article, we are going to teach you all about value investing. We are going to show you what value investing is and how you can use it to start investing today, but that is not all. We are also going to show you the strategies you can use to pick value stocks.
What is Value Investing?
As with any other investing approach before you can start to use value investing successfully you need learn what it is and how it works.
Educating yourself about the different investing approaches is key to being successful in the stock market, the more you know and understand the better you will be at using the approach.
To put it simply, value investing is an investing approach that teaches you how to value a stock.
With value investing you learn how to value a stock, so that you can invest in the stocks when they are undervalued, but that is not all there is to value investing. In the investing world undervalued stocks are commonly referred to as value stocks, which is a term you will see throughout this article.
Learning how to value a stock is just the beginning, as it allows you to identify the value companies. Once you have identified these value companies you then invest in them while they are undervalued and hang onto them for a period of time.
In order for you to profit from value investing you must hang onto your investment until its stock price has recovered or becomes overvalued. Once that happens you need to sell your investments.
How to Value a Stock Using the Intrinsic Value Formula
Earlier in this article we briefly mentioned intrinsic value and what it is, but in order to learn how to value a company we need to discuss it further.
As we mentioned before intrinsic value is the real value of the company. Intrinsic value doesn’t just take into account cash, inventory, and other tangible assets; it also takes into consideration trademarks, copyrights, and other intangible assets to determine the true value of a company.
For investors, calculating the intrinsic value is important because it allows them to make sound investment decisions.
By determining the company’s true value they are able to determine if the stock is overvalued or undervalued.
When the intrinsic value is greater than the market value the stock is considered undervalued, but when the intrinsic value is lower than the market value the stock is considered overvalued.
Investors need to know when stocks are undervalued or overvalued because that alerts them to when it is the right time to buy or sell stocks.
The most popular method used by investors to calculate intrinsic value is the discounted cash flow method.
To use this method you are going to need to know what the company’s expected growth rate is, their free cash flows, as well as their discount rate.
You are going to use that information to determine what their net present value is currently, as well as 10 years into the future.
Once you figure those out you will need to add up all of the NPVs, plus multiple year 10 by 12 for the sell off value. You will then use those numbers along with the Cash & Cash Equivalents to determine the company’s intrinsic value. You can learn more how to estimate a company's intrinsic value here.
You can also get their intrinsic value per share by dividing the intrinsic value by the number of outstanding shares.
How to Build a Diversified Portfolio
One mistake that many new investors make is that they put all of their money into one type of investment. As you can see from this article value stocks are one of the best types of investments for those that are looking to make huge profits.
Even though they can bring you huge profits, only investing in business stocks is not how to build a portfolio.
If you were to invest all of your money into value stocks you are not only putting that money at risk you are also not maximizing your returns.
Investing all your money into value stocks is similar to investing all of your money into a single investment. When investing in value stocks you do so with a risk of losing your money.
The numbers might all look great when you purchase the stock, but there is no guarantee what will happen in the future no matter how good it looks on paper. All businesses are at a risk of going bankrupt, so even if it’s a fundamentally strong business now there is no telling what might happen in the future.
A diversified portfolio is going to include a variety of different types of investments, including EFTs, income stocks, and value stocks.
Diversification is vital for successful investing as it allows you to spread the risk throughout your portfolio. In other words you are not putting all of your eggs into one basket.
Investment analysis and portfolio management are two very useful tools to use when building and maintain a portfolio.
By analyzing your investments and adjusting your portfolio based on your findings you will be able to spread out the risk, as well as maximize your returns.
As you may have gathered from this article, value investing is an investing approach that investors use to find value stock.
It is also what many consider to be the best way to invest in the stock market or at least the most profitable.
Investors use value investing to identify fundamentally strong businesses whose stocks are seriously undervalued.
Investors then buy the stocks when they are undervalued, but sell as soon as they become overvalued in order to make a profit.
About the Author
This is a guest post from Hung Nguyen – Co-Founder of Wealthy Education. Since 2014, he has helped over 10,000 students from over 140 countries learn stock investing and discover a life of financial independence. You can also find him on Twitter, Pinterest, and Facebook.