How Value Investing gives stellar returns with minimal risks
Value v/s Price
Let’s take house prices. They change for all the wrong reasons. They would rise to crazy levels if a Bollywood heartthrob were to buy a flat in the same locality, and fall unreasonably low if the locality got ravaged by a series of uncontrolled thefts. What you pay at any given point of time to acquire that house is its price.
Both are temporary situations and do not change the underlying cost of the land, construction material, quality, or distance from important facilities, and the future growth of the locality. The future potential of price rise in a few years to come is its value.
What is Value Investing
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their current potential value (and accounting for future prospects).
In their expansion cycle, companies that are building capacities, reducing operational costs, cutting down debt, building a competitive moat, are often not favored by the market. Everyone prefers quick gains and it may be a few years before these companies may see the result of their efforts. Hence they are often available at cheaper prices due to lower demand than the current hot stock.
Picking such companies for future gains is called Value Investing.
Why Value Investing works
It’s simple math. An in-demand stock will be expensive. A stock priced at Rs. 1000 and with a potential to go up to Rs. 1100 may only give you 10% returns. Moreover, your risk is very high — buy at its peak and it may fall 50–60%.
But an undervalued stock available at Rs. 350, and having a potential to go up to Rs. 1100, will give you a multifold return even at a minor price increase. And the downside risk is far limited as compared to the hot-shot stock that everyone is chasing.
How can you identify value stocks?
Comparing stock price with its intrinsic value, book value, looking for free cash flows, future opportunities, and competitive advantages over peers are some ways to identify such stocks. While you can use Prospareto Screener to perform the quantitative analysis for your value investing, it will take you some time to excel at the qualitative analysis. But that time spent learning always pays off.
Have any questions about value investing? Focus Investing on Prospareto is a value investing portfolio managed by Mr. Dipen Doshi. You can book a free consultation with him to understand if Value Investing is for you.
Image courtesy: Freepik
Originally published at https://blog.prospareto.com.