Value investing is the stock selection strategy famously used by business magnate and fourth wealthiest person in the world, Warren Buffett, whose total net worth exceeds $92 billion (as of July 2020).
Coined by Columbia University professor and economist, Ben Graham, value investing involves screening securities to find stocks undervalued relative to peers and the market. Stocks are then assessed for their intrinsic value, determined by a fundamental metric—such as the price-earnings ratio—and purchased only if the stock price is less than its intrinsic value.
With value investing, dividends, cash flow, and earnings growth matter more than market factors on the stock’s price. The idea is that the market will eventually correct itself. When that happens, the undervalued stock will rise in price and the investor will make money.
Buffett’s investments have consistently outperformed the market, decade after decade. This is why he became known as the “godfather” of value investing.
Value & Profit Building: Warren Buffett’s story
Buffett enjoyed success following Ben Graham’s investing guidelines, in the 1950s. He, however, began to assess potential stocks differently than his mentor. While Graham kept his focus on the bottom line numbers—the balance sheet and income statement—Buffett looked at a company’s corporate leadership and overall potential to generate long term earnings.
In 1962, Buffett bought Berkshire Hathaway. This was a failing textile company whose shares were valued at $7.50 each. He phased out its textile manufacturing division and transformed the business into a holding company for investments. Buffett was able to build Berkshire Hathaway into the incredibly profitable company it is today. How? He chose to invest in a number of assets that proved lucrative such as insurance, oil, and the media.
Value investing tips
Read these tips from a Business Insiders article on Warren Buffett’s winning investment strategies. You can use these strategies to help you become a more successful investor.
Re-think your diversification strategy
Buffett recommends selecting stocks carefully. This means using an eye for the long-term future by maintaining focus on individual investments rather than hedging bets with a varied portfolio designed to minimize volatility.
Follow the 99-1 rule
Buffett warns investors not to sell as soon as it appears that a stocks’ value is declining—like the 99% do, overreacting as they take in just 1% of the daily financial news.
Play the long game
Buffett’s approach to investing requires patience and commitment. He advises investors to select stocks with potential and hang onto them for decades. Investors who constantly buy and sell may lose out on higher returns. They also end up paying more trading commissions and taxes.
Get started with a formula for value investing
For more detailed information on value investing strategies, including guidelines for how to choose undervalued securities with excellent profitability potential, check out this Investopedia article.
You might also be interested in The Essays of Warren Buffett: Letters to Corporate America. This is a collection of letters Warren Buffett wrote to Berkshire Hathaway shareholders. You can also check out Ben Graham’s classic book on value investing, The Intelligent Investor.