The Motley Fool

What Is: Value Investing

Value investors are very clear in their approach to investing. They assume that over the long-term, a share should more or less reflect the intrinsic value of the company.

A well worn analogy was provided by Benjamin Graham who is recognised as “the father of value investing” and the mentor to Warren Buffett. Graham once said that in the short term, the stock market is a voting machine, but over the long run, it is a weighing machine. In other words, Graham believed that while value shares may be discounted by the market now, they will eventually go up in price when the true value has been recognised.

Interestingly, value investing is sometimes compared against growth investing as being polar opposites. However, the distinctions are largely academic. That’s because growth investors don’t buy shares because they think they may be overvalued. And by the same token, value investors don’t buy shares because they think they won’t grow.

However, value investors do insist on buying companies whose share price is significantly below their intrinsic values.  In other words, they are looking for a good “margin of safety” — that is, a discount to the estimated intrinsic value — even if it means sitting on their hands until the price of a great company falls into an acceptable range. Consequently, value investors rarely follow the crowd. If anything they tend to invest against the market, which is why they are sometimes referred to as contrarian investors.

Some value investors try to only buy shares that have margins of safety of 50% or more relative to their intrinsic value. What’s more, when the stock approaches its intrinsic value, they sell and repeat the process. Other value investors might look for a significant margin of safety but are also willing to pay more for established companies with durable competitive advantages or moats. They believe that in the long term, those wide moats translate into compound market-beating returns.

In all of these cases, however, the value investor is looking to firstly estimate the intrinsic value of the company. Then they judge the stock price against the intrinsic value. And they will only buy when there is a reasonable margin of safety.