Sunday, August 4, 2013

Value Investing 101

Value Investing essentially means investing in assets and businesses that are available below their intrinsic value. What is intrinsic value? There are several definitions of intrinsic value. Intrinsic value is the present value of future cash flows the asset or the business may return. The main challenge is to estimate these cash flows reasonably and discount it.

For instance, I purchased a share of Infosys in 2009. Ideally Infosys generates cash flows to an investor in the form of dividends and special dividends. All we can do to estimate intrinsic value using discounted cash flow method is to discount dividend per share for next few years. Most people agree that it is alright to assume the cash flows till perpetuity.

Value investing makes sense because you are buying something that is worth more. The main challenge in value investing is to avoid value traps. In a bad market every share that drops in price looks like an attractive candidate for value investing. However, one should be very careful and avoid these traps. One way is to select stocks that are already trading below their Price to Book value per share. There are several critics of this practice. But this can make sense if you also consider other aspects of a business like debt, corporate governance, margins, etc.

Buying something that is cheaper is definitely a smart move. In today's turbulent times when stock market is extremely volatile, the only viable method to invest in markets is value investing. It is recommended to avoid any biases and start with a clean mind before selecting stocks.

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