Value Investing in the share market is a process of estimating the value of a company on a per share basis. This estimate of value is often referred to as the company’s intrinsic value.
There are a number of ways to invest in the share market and I have found the value investing methodology to be one that suits my personality. It provides a level of certainty and helps take the emotion out of buy and sell decisions. It provides a process where you determine what you want to buy by assessing the ‘metrics’ of a business and waiting for the market to present the opportunity to buy an excellent performing company at a bargain price.
The process of assessing the metrics of a business helps to avoid businesses that are not profitable or have too much debt. It is a process that does require patience and it is a process that only requires a few good decisions a year to do very well.
And, just like there are a number of ways to invest in the share market, there are also a number of ways to determine an estimate of a company’s intrinsic value. There are approaches that are referred to by terms such as ‘Net-Nets’, ‘Discounted Cash Flow’, PEG ratios etc. I personally use a simple process based on the earnings, dividends, equity, debt level and cash-flow of a business to determine my estimate of intrinsic value.
The reality is that all of these intrinsic value approaches produce similar valuations and I am not interested in entering into a debate about which method is the best. However, I do use my valuation methodology consistently which helps me produce consistent results for my valuations across all businesses and industries and across a long time frame.
When you find value, it hits you over the head. Here is an analogy from the property market to help me illustrate my point. Suppose you are looking to buy a 3 bedroom home with a bathroom and a single garage in a metropolitan suburb in one of our capital cities. You might know that the market price for this sort of home is $350K. Some people might say that it is only worth $340K because it needs a new bathroom. Another person might say it is worth $345K because the bathroom is ok but it does need a coat of paint. Another potential buyer might be prepared to pay $355K because it has a big backyard ideal for the kids.
Now, if this particular property came onto the market for $290K, you would instantly know that it is a bargain. You could estimate that the property is worth between about $340K and $355K depending on who is valuing it. The value of the property at the bargain price of $290K hits you over the head.
Value investing works in exactly the same way as the property illustration highlighted above. While determining an estimate of intrinsic value, I know that I am approximately right and not completely wrong. Being approximately right gives me the peace of mind and certainty to make good investment decisions when the share market presents the opportunity to buy a bargain or two.
So when I am hit over the head by a great business that has been marked down by the share market and I can buy it for $2.90 when my estimate of intrinsic value is $3.50 per share and rising, I have given myself the certainty to buy the bargain.
This article is published by Dean Mico.
The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.