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The Basics Of Value Investing
By: D. Moore
Value Investing refers to a philosophy or practice of buying stocks that are
fundamentally sound, but the stock price is below its obvious value. There are
various indicators that Value Investors use to determine that a company is both
sound and the stock price is undervalued. For the Value Investor, perhaps more
than any other style of investor, is more concerned with the business and its
fundamentals than other influences on the stock’s price.
Fundamentals, such as dividends, earnings growth, cash flow, and book value are
more critical than market forces on the stock’s price. Value investors are
generally buy and hold investors. They will hold a stock for long term periods
and are not concerned with short term swings in the stock price.
When the Value Investor determines that the fundamentals are sound, but the
stock is trading at a price below its obvious value, he or she knows that this
is a potential investment candidate. The assumption is that the market has
incorrectly undervalued the stock. Conversely, when the market corrects that
mistake, the stock’s price should increase towards the obvious value point.
How do Value Investors find a potential investment?
- price to earnings ratio is in the bottom 10 percentile for its sector
- debt to equity ratio is less than 1
- price to book value ratio is less than 1
- PEG value of less than 1
- Stock value is trading at 60-70% of its intrinsic value
The P/E (Price to Earnings Ratio) is calculated by dividing the current price of
the stock by the annual earnings per share. The higher the P/E the more earnings
growth investors will expect and the higher premium they are willing to pay for
that anticipated growth.
Debt to equity is calculated by dividing the total liabilities by the
shareholders equity.
Price to Book Value is calculated by taking the current price per share and
dividing by the book value per share.
The PEG is calculated by taking the P/E and dividing it by the projected growth
in earnings.
The intrinsic value of a stock is a complicated process and is considered an
inexact science by most investors. The intrinsic value of a company or an asset
is generally determined based on an underlying perception of the value. Brand
Name, Goodwill, and barriers to entry in a market are some of the factors that
will determine the intrinsic value of a stock. You may be interested in looking
at MorningStar.com for helping you determine a stocks intrinsic value. They
calculate a number called “fair value” which is similar to intrinsic value.
Many investors have increase their wealth substantially using a value-based
approach to investing. This overview of Value Investing suggests a philosophy
that works well over time if you buy carefully and use patience to hold for the
long term.
About the Author:
Derek Moore is the administrator and webmaster of The Investors Daily Website.
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