Value Investing What is Example Concept Growth Investing

Often, there are stocks in the market that are undervalued—however, they do have strong fundamentals. When investors pick these stocks, they’re value investing. What they’re essentially doing is picking stocks that are trading below their intrinsic or book value.

Although it was Benjamin Graham who came up with this concept of value investing, it was Warren Buffett who made it popular. Let’s know more about this, look at it with Indian examples, and see some important questions related to this strategy.

So, what’s ‘Value Investing’?

An investor typically goes out searching for underpriced stocks in the market. How can you know which stock is undervalued? They are usually characterised by three things: low price-to-earnings ratios, high dividend yields, and low price-to-book ratios. The basic idea there is to buy these stocks at a discount to their intrinsic value and hold them until the market realises the stock’s true worth. That’s basically value investing.

Let’s understand this better through an example of Tata Motors. These are the steps that are usually followed:

Identifying the undervalued stock: Tata Motors is one of India’s largest automobile manufacturers. Consider it might be trading at a price which is appearing less than the intrinsic value. It could be on account of temporary setbacks in the automobile industry or economic downturns or decline in sales.
Analysing key metrics:

Metric	Example Value (Tata Motors)	Industry Average	Implication
P/E Ratio	8	15	This could mean that the market may be undervaluing earnings potential.
Dividend Yield	5%	3%	This indicates that the stock might be undervalued.
P/B Ratio	0.8	-	It points to the possibility that the market price is less than the company’s net asset value.

Assessing the intrinsic value: The intrinsic value of a stock is its perceived true value. How an investor estimates this is based on the company’s fundamentals, which include earnings, dividends, growth prospects, and assets. Value investors will calculate the intrinsic value of Tata Motors through a series of tools and methods. One of them is the DCF-analysis method. For this method, future cash flows are projected and then discounted to their present value.
Buying at a discount: After studying and analysing, an investor comes to believe that the intrinsic value of Tata Motors is Rs 600 per share. But the current market price is Rs 450. Here, the investor has a very healthy margin of safety and can buy the stock at a discount of 25% of its intrinsic value.
Holding until market realises its true worth: Patience is key for value investing. The investor will continue to hold on to Tata Motors’ stock believing that the market would eventually realise the true worth of the company. Once the company does better, once market sentiment changes, or as soon as industry conditions stabilise, the stock price may increase to its intrinsic value of Rs 600.

What happens after value investing?

Let’s look at the potential outcomes.

There is a favourable scenario: The stock price moves up to Rs 600 eventually and there is a reasonable amount of profit made. This scenario occurs when the company is improving its performance, launching a new product, or simply when the overall industry trends are favourable.

There is a bad scenario: The stock price does not reach the intrinsic value that was estimated by the investor or the company’s fundamentals turn out to be worse than anticipated. Then, it’s time for the investor to review the investment and decide whether to stick with it or exit the underlying stock position.

Understanding the differences between Value and Growth Investing

Criteria	Value Investing	Growth Investing
Investment Focus	Undervalued stocks with strong fundamentals	Stocks with high growth potential
Risk	Generally lower due to the margin of safety	Higher due to reliance on future growth
Time Horizon	Long-term	Can be both short-term and long-term
Examples	ITC, Coal India, SBI	HDFC Bank, Reliance Industries, Bajaj Finance

The Role of Behavioural Finance in Value Investing

There are many psychological factors that affect financial decisions and market outcomes. Behavioural finance studies all this. In value investing, understanding these factors can help investors avoid common mistakes like overreaction to market news or following the herd.

Key Behavioural Finance Concepts

Concept	Description	Impact on Investing
Overconfidence	This is when an investor overestimates their knowledge, proficiency, and capacity for market prediction. It often leads to excessive risk-taking and frequent trading.	1. Overconfident investors may be engaging in too much risk because they believe they can outperform the market. It may make one incur higher transaction costs and losses 2. For example, an overconfident investor might keep buying and selling stocks based on temporary market movements, thinking they can time the market accurately. This often turns into lower returns.
Herd Behaviour	Herd behaviour occurs when investors follow the actions of a larger group instead of relying on their own judgement. This can lead to irrational investment decisions, such as buying overvalued stocks or selling undervalued ones.	1. Following the crowd could lead to buying overhyped stocks during a market bubble or panic selling when the market falls. This may increase the volatility of the market and result in big losses. 2. For example, during the dot-com bubble, many investors bought tech stocks because others did it. It led to overpriced stocks and then sharp declines later.
Loss Aversion	1. Loss aversion is the tendency of investors to avoid losses rather than making equivalent gains. 2. This psychological bias means that the pain of losing is more intense than the pleasure of gaining.	1. A loss-averse investor might hold on to losing stocks for too long hoping that he would avoid a loss. He might not invest in higher-risk, higher-reward opportunities at all. 2. For example, an investor might refuse to sell a declining stock to avoid the mental stress of a loss—even when there are better investment opportunities. They are likely to miss some potential gains in doing so.

Want to dive deeper into this? We have some books for you. Read these books if you’re interested in some deep insights and analysis:

“The Intelligent Investor” by Benjamin Graham: This is a classic book that forms the basis of value investing principles.

“Security Analysis” by Benjamin Graham and David Dodd: It is a detailed guide to analysing securities and determining their intrinsic value.

“Common Stocks and Uncommon Profits” by Philip Fisher: This one explores the qualitative aspects of investing in stocks.

“The Little Book That Still Beats the Market” by Joel Greenblatt: It introduces the concept of the Magic Formula for picking undervalued stocks.

How to Get Started with Value Investing

Now that you have a basic idea, getting started with value investing requires you to clearly understand it. Here are a few steps to take you ahead:

Educate yourself: Knowing is the key. Go through books, courses, and other resources on the value investing that are readily available online.
Analyse financial statements: Become well-versed in financial docs. Learn to not just read but also interpret balance sheets, income statements, and cash flow statements.
Calculate intrinsic value: Get technical. Use methods like DCF analysis to determine the true worth of a stock.
Build a Diversified Portfolio: Put your research to use. Invest in various undervalued stocks across different sectors to minimise risk.
Monitor Your Investments: Always know what’s going on. Keep track of your investments and adjust your portfolio as and when the market changes.

So, now we know that value investing is a great way to help grow one’s wealth in the long run. Just pay close attention to the undervalued stocks with good fundamentals combined with a margin of safety. Put your knowledge to use while remembering the risks, and start having fun with value investing!