What is Value Investing?

Warren Buffett once said, “Price is what you pay; value is what you get.” That quote captures the essence of one of the most time-tested and successful investment strategies in history.

So what is value investing? Investors like Buffett use it to find stocks whose prices are lower than what they believe they’re really worth. They then buy those stocks and sit on them with the aim of building long-term wealth.

In this guide, we’ll show you how value investing works, which metrics matter most, and whether it’s a strategic fit for your financial goals.

What is Value Investing?

Value investing is the practice of purchasing stocks that are priced lower than their perceived intrinsic value. Intrinsic value is what a stock is actually worth, based on fundamental metrics like earnings, assets, and cash flow.

If a stock is trading below its intrinsic value, it may present a buying opportunity. If it’s trading above, it might be time to sell. The long-term strategy of value investing focuses on businesses with strong financials and durable growth prospects that are often overlooked within the broader market.

Unlike growth investing, which targets companies with the prospect of rapid expansion, value investing leans into consistency and stability. It often means taking a contrarian view and finding potential in sectors or names others have discarded.

Value Investing and Intrinsic Value

Determining intrinsic value involves a combination of financial analysis and market research. Some key indicators include:

• Price-to-book (P/B) ratio: Compares stock price to a company’s book value. A lower P/B may indicate undervaluation.
• Price-to-earnings (P/E) ratio: Evaluates current share price relative to earnings. A low P/E can suggest a bargain.
• Free cash flow: Cash generated after expenses. Strong free cash flow shows a business can reinvest, pay dividends, or repurchase shares.

Other factors that shape intrinsic value include a company’s business model, revenue consistency, brand strength, and its competitive edge.

Advantages of Value Investing

• Lower downside risk: Buying undervalued assets often means there’s less room to fall.
• Focus on fundamentals: Rather than reacting to market noise, value investors lean on analysis and facts.
• Tax and cost efficiency: Buy-and-hold strategies typically mean fewer transactions and lower capital gains taxes.
• Long-term potential: By ignoring short-term swings, value investors aim to benefit from compounding returns over time.

Disadvantages of Value Investing

• Slow payoff: Undervalued stocks can take time to rise. Investor patience is key. 
• Research-intensive: Requires thorough analysis to distinguish genuine opportunities from “value traps,” stocks that appear cheap but face structural problems or deteriorating fundamentals.
• Difficult timing: It’s hard to call a true market bottom, which can delay or challenge entry points.

Best Value Investing Strategy

Here are a few tips to help you get started with value investing.

1. Watch Market Trends, But Don’t Chase Them

Don’t let volatility dictate your decisions. A disciplined focus on fundamentals beats reactive trading.

2. Avoid Chasing Market Bubbles

When stock prices detach from reality, crashes follow. Value investors like Warren Buffett steer clear of overhyped names.

3. Hunt for Overlooked Opportunities

Undervalued stocks aren’t always glamorous. Explore small caps, foreign markets, or unloved sectors.

4. Understand the Bigger Picture

Temporary setbacks, like bad earnings reports or negative headlines, can create buying opportunities for fundamentally strong companies.

Getting More Out of the Stock Market with Value Investing

Investment goals, time horizon and risk appetite will play a big role in choosing your investment strategy. The chance of generating higher returns with lower risk makes value investing a great choice to consider. 

Don’t forget, however, that you must research and analyze your options before you invest. No strategy is risk-proof, and you should always be prepared for a downside. 

Frequently Asked Questions