(As always, when it’s Tuesday, that means it’s time for another thrilling edition of Investing 101. This week, we’re going to look at something a little bit different, in this case, value investing. Rather than a single investment or set of investments, as with most of our Investing 101 columns, we’re going look at an entire investing philosophy. Given the sheer amount of depth in this subject, there’s no way I can cover everything about value investing in one post, or for that matter, even in a week. Although, this week will cover quite a bit of value investing basics; yesterday’s post on present and future value covered some of the calculations frequently used by value investors. And now, more of the basics of value investing.)
Q: What is value investing?
A: That’s a rather broad question, and one that’s difficult to answer. Value investing means different things to different people, and the variety of opinions sometimes leads to misunderstandings. In a nutshell, value investing requires looking at the intrinsic value of a company, and buy stock in the company as if you were buying the company itself.
Q: As if I were buying the company? What’s that supposed to mean?
A: Well, unlike technical investors or others who focus on stocks as entities separate from the underlying business, value investors evaluate the shares of stock they consider purchasing as, well, ‘shares’ of the company they are considering. As a result, they look closely at the issuing company, evaluating its present state and future prospects, trying to determine how much the company is worth.
Q: How do you do that?
A: The most basic idea behind value investing is to calculate the intrinsic value of the company. By making some smart assumptions about how the earnings of the company will grow in the future, it’s possible to determine a reasonable estimate for how much the stock is worth in terms of future growth. It requires you to make assumptions (based on carefully considered research) on the future growth and run several calculations based on those numbers.
Q: That sounds kind of complex; are there any easier ways to run these calculations?
A: There are numerous online calculators that can be used to run intrinsic value calculations. One I particularly like comes from MoneyChimp. Or, if you prefer a more home made touch, I produced my own intrinsic value spreadsheet, based on the calculations listed in Value Investing For Dummies.
Q: Wow, so all I do is plug numbers into these calculators, and they’ll tell whether I should buy these stocks or not?
A: In theory, yes. In practice, all intrinsic value calculations require you to make assumptions about how much the company value will grow in the future. As a result, the values you get are only as good as your assumptions. If you do plenty of research and come up with good values, you’ll likely have results that come close to reality. How you do that is the basis of value investing.
Hope that gives you a better understanding of value investing, as well as some tools to help you calculate the value of the stocks you in which you seek to invest.