“Price is what you pay, Value is what you get”
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Much has been written about the principles of ‘Value Investing‘ since Ben Graham and David Dodd, brought the concept of ‘Value’ to the mainstream with their 1934 book, “Security Analysis”, which remains one of the most iconic pieces of financial literature ever written. Their idea was simple – buy securities that trade below their Intrinsic Value. In many ways, the seemingly simple principal derives its inspiration from rather hard to follow traits of common sense and discipline.
What is the Intrinsic Value of Share?
Often, the market price of well established stocks with strong financial and business track records declines for little or prolonged period(s) due to difficult economic envirnoment or due to a temporary setback in business. Such declines can happen for a variety of reasons which may be as diverse as a bad management decision, or trouble in the oil producing OPEC region. Value investors seek to take advantage of these price movements to select stocks which are trading below (or may be far below) their intrinsic value.
A lot more work has been done in devising ways to calculate the intrinsic value of share. Fundamental analysis is the principal approach used by value investors in intrinsic value calculation. Analysts have devised numerous simple and complex techniques to conduct such analysis. No matter what approach one follows, the underlying theme remains the same – to investigate whether the intrinsic value of share is less than its market price.
BY HOW MUCH? The answer to that question is simple, calculate the intrinsic value or real worth and compare it with the market price of the security under investigation. Higher the differential, more is the margin of safety. It is difficult to state the meaning of intrinsic value in a few sentences. Think of it as the real worth of a share which is arrived at, after detailed analysis of the financial statements, and of the future prospects of the business.
The main purpose of any intrinsic value calculation is to help the investor in finding undervalued stocks which are fundamentally strong. While it is easy to discover such stocks, it is difficult to know when their market price will recover. Further, while every single investor buys a stock hoping that it will trade higher in future, their definitions of ‘future’ differ. Some have a 2-3 month horizon, while others look as far as a few years. Value investing could frustrate investors (and may harm their portfolios) if they have a short term investment time horizon.
No matter what your approach is, if you want to spot bargains, you can benefit immensely from the principles of value investing and the art of fundamental analysis.