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June 5, 2024

Wednesday Investment Wisdom: Value Investing Explained

by Detlef Glow.

Value investing is an investment strategy where the investor is buying securities which he thinks are worth more than their current price. This means the current price on the exchange is lower than the intrinsic or book value of the respective security. These evaluations are called fundamental analysis and are mostly derived from the current balance sheet and the respective quarterly updates.

Some of the more prominent measures used by value investors to determine if a company’s stock is a value investment are:

– price-to-book ratio

– earnings-per-share

– free cash flow

dividend yield

Obviously, there are many other measures used to analyze the intrinsic value of a stock. A full analysis would always include the debt structure, as well as an in-depth debt-to-equity analysis, a sales and revenue growth analysis, and a general evaluation of the quality of the balance sheet.

In addition to these quantitative measures, value investors also often conduct qualitative research including an assessment of the company management, governance framework, and the general growth perspective of the respective industry sector.

 

Margin of Safety

The margin of safety is the key element for value investors. Since value investors, like all other investors, have to make a lot of assumptions within their analysis, they prefer to buy their securities at a discount. This so-called margin of safety should help to protect them against errors in the judgements derived from the respective analysis since some of the measures are highly subjective, while others are predictions which depend on external factors. The bandwidth of the margin of safety differs between investors. While Benjamin Graham, the father of value investing, has set the margin of safety at 33%, Warren Buffett, one of the most prominent value investors, requires a margin of safety of 50%.

As to be expected there are many funds and ETFs which follow a value approach available to investors around the globe. Given the high number of funds and ETFs, one should not be surprised that the number of different value approaches is also very high. This means that investors need to do their own research on the implemented investment approach of a given fund because they need to understand how the manager selects the securities for their portfolio in order to compare and evaluate the performance of the respective fund/ETF.

Even as value investing is most prominent for equities, it is also a valid investment approach for bond funds/ETFs.

In addition, it is noteworthy that value investing is considered as one of the factors which can generate additional returns, the so-called alpha, for factor-based portfolios.

 

This article is for information purposes only and does not constitute any investment advice.

The views expressed are the views of the author, not necessarily those of Lipper or LSEG.

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