Jab aap stock market me invest karne ka decision lete hain, toh aap khud ko ready karte hain: investment strategies ke liye, stock market ke jargon ke liye. Even so, every once in a while aisa koi term sunne ko milta hai jiske baare me detail me janna important ho jaata hai.
One such term is value investing. It is an investment strategy in which you - the investor - picks stocks trading for less than their book or intrinsic value.
This means that you study the market, actively search for stocks that are undervalued in the market - and then invest in them. Now it makes sense why it is called value investing, eh?
So basically it is the value investor’s belief that the market overreacts to any bad or good news. For example, Agar zara si bhi indication aati hai ke kisi company ka koi supply cancel ho gaya hai, the market will go bonkers and the stock prices of the company might fall. However, we all know that there are many possibilities in this situation. One, it might just be a rumour, Two, even if it is true, it might be just a temporary setback. Three, the company might actually have a plan of action already in place to deal with this situation.
In such situations, the volatility is only temporary. Iss volatility ka matlab ye nahi hota ke company ke fundamentals weak hai - in fact, these ups and downs are only short-term.
Value investors iss baat ko samajhte hain, which is why they look at this as an opportunity to buy undervalued stocks at a discounted price. Because these are usually profitable stocks, the value investor stands to gain in the long run.
Of course, on the face of it, it may seem counter-intuitive to do that. WHy would anyone buy a stock whose price has- sort of fallen. But value investors tend to go against the grain in their investment decisions, and invest for the long-term in companies they have estimated as valuable.
Its possible ke aapko value investing ka funda samajh a raha hai and that you are tempted to try your hands at this strategy. Before you dive in, you should know a few things. Let me take you through some features of value investing.
First of all, undervalued stocks ko khoj nikalna aasan kaam nahi. Yes, it has a lot of scope ONCE you find a stock, but finding the stock - that’s where the entire hardwork lies. There are a lot of metrics to consider, and the risk can be high if you invest in a stock that doesn’t perform.
Second, value investing long-term ke liye ki jaati hai - that’s the only way to make the most of it. In a few years, the investment in these stocks will show massive returns!
And finally, value investing would require you to adopt contrarian thinking. You have to think against the grain - you have to reject the efficient market hypothesis - it goes against the market movements, but if you are convinced of your analysis, it is a bet that pays off in the future!
Now that you have familiarised yourself witht eh concept of value investing, let’s look at the concept of intrinsic value. Here’s the deal: value investors ek complicated decision par investment karte hain, but how do they arrive at this decision? They use various tools and financial metrics to discover the intrinsic value of a stock. If a stock is undervalued, this is equivalent to its share price being on sale.
Let me put it this way: you go shopping and buy some really expensive items from a branded store. The secret is that you actually got them for cheap since they were on sale. So you end up owning things worth Rs 2500, but you only had to pay Rs 1800 for it.
Very similarly, the investors invest on these discounted prices and hope to profit from these discounted prices. Intrinsic value plays a major role here. Isko calculate karne ke liye you can use a wide variety of financial metrics: whether you are studying a company’s financial performance, looking at its earnings, assessing its revenue or profit or making judgements based on the cash flow.
In addition, you also have the company’s fundamentals like its business model, brand, competitive advantage, and target market.
Let’s discuss the ways in which intrinsic value is calculated by value investors:
One, Price to Earnings Ratio. The P/E ratio helps assess if the company’s earnings are completely reflected in its current stock price. Basically, P/E ratio is reflective of its actual performance. SO if P/E reflects that the earnings are good but the stock market shows the price of shares to be low, it indicates that the company is undervalued! The second tool is the Price to Book value. Working on the same lines as the P/E ration, P/B ratio compares the value of a company’s assets to its current share price. if its share price is lower than its asset value, its stock is probably undervalued.
Another parameter is the cash flow of the company. Company ke operations se aane wale revenue me se expenditures deduct kar diye jaayein, then we get a true picture of the actual cash flow. Often, it happens that company’s operating and capital expenses are through the roof, and THAT is not a good look! This is where free cash flow is a useful analysis tool. Free cash flow is the remaining cash after all expenses have been taken care of. When a company generates a lot of free cash flow, it has more left over to pay off any outstanding debt, reward shareholders or pay dividends, invest in the future of the business, and issue share buybacks.
We can also look at the company’s debt obligations. The higher the debt obligations of a company, the more high risk is it.
One last piece of advice if you are trying your hand at value investing: keep some space for risks, keep some margin for mistakes. After all, value investing ka saara premise hi risk par based hota hai, you want to minimise the blow if things don’t turn out as expected.
If things do turn out the way you wanted, then it would be a big feather in your cap!