When we look at what kinds of companies to invest in, we all have different ideas in mind on what makes a company worthy of receiving our money.
We might look at things like profitability metrics, whether or not the company has strong leadership, or perhaps we care about whether the company shows any kind of social consciousness.
No matter what we look for in a company to invest in, we want to make sure we are getting good “value” for our money.
Robert writes in, “Mike, thanks for the insight as always. After reading the headlines the past few weeks, and seeing how the market acts, it makes me wonder if trying to find a good value stock is worth it, or if I should just buy the S&P 500 indexes and let it ride. Hope you can give some good pointers here. Thanks.”
No matter what we are buying, we are making sure we are trying to get “value” for our money. Even if you are buying the S&P 500 index funds, you are still trying to buy value and hoping you will get more money than you started with. The only difference in classic value investing is how you go about doing it.
In classic value investing, you are trying to put a price tag on what a company is worth based on different things, like annual cash flow or book value. From there, you compare the price that you believe a company is worth to the price that it is currently trading at.
If you can buy the company for less than what it is trading at, then you are receiving it at a good value, in theory.
The idea of value investing has a few celebrities that champion it, most famously Warren Buffet. He has become famous for making a lot of money using theories taught by his teachers, Benjamin Graham and David Dodd.
Some of these theories include things we have mentioned, like cash flow analysis, and also analyzing the margin of safety of your investment. Essentially, you want your potential investment to be so undervalued by your analysis that if you are wrong, it will lessen the blow.
Now, you might be wondering how one might value a company based on its cash flow, book value, or profitability. We will dive into this question in future posts as part of our “How to Price Stocks” series.
For questions on this topic, please leave a comment below.
Thank you for reading. This article should not constitute legal advice. For help regarding your specific situation, please consult a local advisor.