Value Investing

I grew up in a business-focused family. Value investing felt familiar when I started studying it in early 2007. The following two years were a stressful time to start investing, but the financial crisis was also a once-in-a-lifetime opportunity.
I write about value investing at 50-Cent Dollars.

“Value investing” is a redundant phrase. Why invest if there isn’t any value? However, most market participants misunderstand the meaning of the term “investing”, confusing it with speculation. So adding an adjective is necessary.

Value investing is based on the premise of buying something for much less than it’s worth. “Much less” because the difference between the intrinsic value and the market price must include a margin of safety. The margin of safety allows for errors in the investor’s valuation.

A diagram of value investing
A diagram of value investing from www.kclau.com.

So if you estimate that a stock is worth $100 per share, you wouldn’t buy it for more than, say, $66. The $34 difference is your margin of safety. That way, if the real intrinsic value is 20% less than you think–so $80 in this case–buying at $66 still gives you some breathing room. Because valuation is a fudgy process, buying right at an estimate of intrinsic value would be foolish.

To quote an economist who later became an investor:

It is better to be roughly right than precisely wrong.
~ John Maynard Keynes

But value investing is in stark contrast to what most market participants do: speculate. Most buy stocks based on the assumption (and often blind hope) that someone in the near future will pay more than they did. Little attention is paid to what the stock is worth or the future of the business that it represents.

I’ve had some success with value investing but I still have a lot to learn. While I’m comfortable bantering with experienced people about climbing or endurance training, if I were in a room full of experienced value investors, I’d rather keep my mouth shut and listen.