What is Value Investing?

Value investing is a strategy that involves picking stocks that seem to be trading for less than their intrinsic value or book value, meaning the market is underpricing the company, and the stock is therefore considered on sale.

In the same way, grocery stores run sales on various items, the stock market often prices in sales. This commonly happens when the market overreacts to some bad news, leaving the stock price much lower than what the company's financials reflect.

Sometimes the stock gets unjustly beaten down. When this occurs, value investors have the opportunity to buy what looks like a stock that's on sale.

Examples of these companies include Exxon Mobil, Johnson and Johnson, General Electric, and AT&T, which have been pessimistically valued by the market for various reasons.

Value investors do their own financial analysis of metrics such as price to earnings, price to book, cash flow, and risk assessment, in addition to debt-equity, sales, and revenue numbers.

These types of investors usually do the opposite of what others are doing; they buy a stock that most of the market isn't interested in, that's been sold off, or that was just never bought up.

When a value stock is purchased, the investor believes that eventually the market will accurately price the stock, and their return will be significant since they purchased it at a discount. They also allow for a margin of safety; if you know the value of something, you can save a lot of money when you buy it on sale instead of paying full price.

Stock prices are ever-changing, even if the valuation of the company has stayed the same. Just look at the stock market on any given day; prices jump up and down, even though there hasn't necessarily been any news on a particular company. In the same way, prices in the grocery store are ever-changing.

Value investing is a long-term strategy, so once your selections have been made, there isn't much further effort required. This results in lower volatility and risk, as frequent buying and selling aren't necessary, since you made a purchase at a discount instead of paying a premium.

Many value stocks also have considerable dividend yields since their stock price has been beaten down, but the dividend payments remain the same due to stable financials. This allows shareholders to enjoy regular income, which can either be reinvested or used to fund retirement expenses, further adding to the stability.

Compare this style with that of growth investing, where a stock is purchased presumably at a reasonable price based on its future growth. The growth stock provides little to no income, further illustrating that value investing is a lower risk.

In other words, growth investors are making investments based on expected increases in earnings that are higher than those of other stocks. Keeping your emotions in check while using this type of investing is required.

In some cases, this can make investing easier, but it can also be a challenge when you see other investors following the herd. A good example of this herd mentality is the dot-com bubble; investors riding that bubble were making spectacular returns only to lose most of it.

Following the herd can work sometimes, but at some point, that mentality leaves you with money lost when stocks or sectors end up in a bubble that bursts. Decisions must be made based on data and analysis instead of feeling in hopes of increased earnings in the future. This is what will ensure you make money over the long term instead of just riding a bubble to the top of the market.

Value investing requires the proper knowledge of how to analyze and value a company, something not everyone's cut out for. Learning to evaluate a business requires both time and effort and waiting to see the results of your hard work will entail a great deal of patience.

Watching your stocks rise in value can sometimes take years; it's not a very exciting process. This can present a very real challenge to those investors who crave the excitement of generating big returns quickly. On most days, in fact, value investors will see very little change in the value of their stock holdings.

Warren Buffett, who ranks on the Forbes list of billionaires as the fourth richest person in the world, has been following value investing principles for his entire career. Of course, he's the businessman in charge of Berkshire Hathaway and a philanthropist, but he's best known for being one of the world's most successful investors by consistently purchasing companies that he sees as undervalued, in the same way a shopper looks for bargains.

Buffett avoids hot sectors that are over-inflated. Some of his largest holdings include Bank of America, Coca-Cola, and Kraft Heinz. When Buffett invests in a company, he isn't concerned about whether the market will eventually recognize its worth; he is concerned with how well the company can make money as a business.

This investing style is that of a practical mentality, instead of being overly optimistic and investing based on hope. Perhaps the stable, healthy returns he's been able to generate over his career allowed him to outperform alternative growth strategies.

After all, he's been successfully investing since 11 years old, so he might know a thing or two. If you like the idea of performing fundamental analysis on your potential holdings, individual stocks can be purchased, providing the potential for astonishing returns.

Earning returns like Warren Buffett is certainly attractive, but he claims to spend five or six hours every day reading financial reports and newspapers. He enjoys reading financial material, but others might find that extremely boring.

For many, buying an ETF or index fund that only holds value stocks is a stable and easy alternative. Vanguard offers a value ETF, VTV, which provides exposure to around 350 different companies such as JPMorgan Chase, Verizon, AT&T, and more.

The largest sectors are healthcare and financials, which seem to be undervalued compared to other sectors such as technology. Purchasing this fund will provide about a three percent dividend yield while charging just a 0.0 percent expense ratio.

Many other ETFs and index funds have similar holdings offered through other companies, so don't feel like you need to be a genius at fundamental analysis to be a value investor. Simply buying and holding with no further research is a great way to make passive returns.

If following the investing style of Warren Buffett sounds like something you'd like to pursue, you should take a look at your options, be prepared to go against the crowd, and invest your money in places that might not be providing huge returns at any given time, knowing that at some point your patience will be rewarded.

It might take months or years for your positions to catch up to the market to the point where they're valued properly, but that's okay if you know the value of your holdings and are confident in your decisions. Buying quality businesses at discounted prices can reduce your risk and provide higher-than-average dividends. If you choose to buy individual stocks, be prepared to do extensive research before finding profitable investments.

On the other hand, you could simply put your money in a fund that only holds value stocks and passively wait for your investments to provide returns. Regardless, value investing is a proven strategy that has many advantages, even though it might not be the most glamorous.