What is Value Investing?
It is the art and science of looking to acquire $1 worth of assets for a price well below that amount, and sell it, when appropriate, at a higher price.
The key concept is “worth”. It is the inflation-adjusted, time-adjusted net present value of all future earnings from that asset. The future earnings include, of course, the proceeds when the asset is sold, but also any income that the asset generates during the holding period.
The holding period is the time during which the asset is owned by the investor.
Now, the “worth” of an asset is often not easily quantifiable. That is where the art and science, mathematics and intuition, experience and aptitude meet. One has to have a well-grounded idea of not only the elements of value that asset includes (such as expected earnings and its “moat”), but also the environment that influences its quality over time. For example, supply and demand factors play an important role in the equation.
The explanation above is valid for all kinds of assets, ranging from real estate to art. Different assets have different characteristics, attributes and factors influencing their value. These range from the liquidity, replaceability, and transparency of facts that matter.
Among the easiest to evaluate are shares of companies listed in the stock market. One can have access to detailed information about past activities and present standing of the company. These are available in the balance sheet, income (profit and loss) accounts, and cash flow statements. One looks at the historic records of the company as well as its competitors to get a feel of how well the management has been doing. One also studies industry trends to gauge how the company is likely to perform in the future. The investor also judges whether the management of the company has both the integrity and acumen to deliver returns to the shareholders. Accounting practices reveal how conservative and transparent the management is, while remuneration data suggests whether the interests of the management are aligned with the shareholders.
Finally, an entire company – which is how the stock investor must view his investment – is meant to be a generative, productive asset. Generative assets are those that produce value during their lifetimes. This includes land, factories, and systems. To that extent, gold is not considered a generative asset – it does not reproduce itself or produce any other material of value.
Note that value investing is a long-term strategy. It requires research, discipline, and patience. Technical analysis, speculation, and jumping in and out of positions in the short term are not part of value investing.