Three Common Strategies Of Value Investing You Need To Know
Value Investing is Not A Strategy
As we established in the beginning, value investing is not a strategy for investors. It is rather a philosophy on which to guide investors. As mentioned by Warren Buffett on the “Superinvestors of Graham-and-Doddsville”, the super investors have different strategies and owned different stocks on their portfolios. Nonetheless, each of them was able to produce great performances in their own way.
So, if value investing itself is not a strategy, what are some of the strategies that great investors used? Now, let us look at three of the common strategies of investing.
Deep Value: Searching For That Cigar Butt
The beginning of value investing starts from Warren Buffett’s mentor, Benjamin Graham. Graham is famous for being a deep value investor. He had a strict approach when it comes to valuing a stock. He is also famous for finding stocks that are trading very cheaply to their net asset value. Warren Buffett coined this style of investing as the “cigar butt” method.
Basically, an investor that practice this form of strategy is searching for a company that is trading way below its net asset value. The idea is to find a company that is so cheap that it would be profitable for the investor to liquidate the company after he/she buys it.
Here is an example:
Company A has a total asset of $100 million and has S$50 million of liabilities. This means that company A would have a net asset of $50 million. Moreover, its assets are relatively liquid assets that can easily be converted into cash. This could be properties it owns, its inventory, its short-term receivables or even cash the company is holding.
If the company has an outstanding share count of about 100 million, it would have a net asset per share of $0.50 per share. So in theory, a deep value investor might buy the company if it is only trading at $0.20 per share. This means that even if the company is to close down and sell all its assets, the investor would still be able to profit from it. In essence, the investor is buying its net asset, that is worth $50 million at just $20 million, a 60% discount.
Dividend Investing: Show Me The $$$
Another strategy of investing is focusing on the dividends of a company. This follows a simple idea of “Money in my hand is better than money in the management’s hand”. An investor’s job is to allocate the funds toward the best possible investment. A job of a company is to generate returns for investors. Therefore, a dividend investor will look for companies that pay a decent dividend that allow him/her to reinvest at a constant schedule.
A dividend investor would look at these factors when deciding on an investment.
- Company can sustain its dividend payout
- The company has potential to increase its dividend payout
- A strong balance sheet
- A fundamentally strong business
Dividend investing has some very unique advantages over other strategies. One of the biggest advantages is that the investor would be getting a steady stream of passive income from his portfolio. However, if you are from a country that taxes your dividend income, you need to consider that loss of income as well.
Growth Investing: The Sky Is The Limit
Lastly, there is a segment of value investors who focus on growth investing. “Wait a minute!” You might say. Isn’t growth investing the opposition of value investing?
The short answer is “No.” It is a common misconception that growth investing is NOT value investing. However, as explained by Warren Buffett, growth is simply a function of value. All fundamental investors who invest for the long term, can be considered as a value investor. Therefore, even fast-growing companies such as Tencent Holdings ([stock_quote symbol=”HKG:0700″ show=”name” nolink=”1″ class=”1″]) or Alibaba Holdings ([stock_quote symbol=”NYSE:BABA” show=”Name” nolink=”1″ class=”1″]) can be possible investments for value investors.
In growth investing, the investor is not looking at the assets or dividend of a company. The biggest concern for the investor would be the growth rate of the company and its current size to its addressable market.
The addressable market is the potential of the possible customer base for the company. A local telecommunication company like Digi.com ([stock_quote symbol=”KLSE:DIGI” show=”Name” nolink=”1″ class=”1″]) will have a much smaller addressable market than a global company like Singapore Telecommunication ([stock_quote symbol=”SGX:Z74″ show=”Name” nolink=”1″ class=”1″]).
Thus, growth investors prefer to look for companies:
- In a fast growth sector
- A large addressable market
- Strong management team
- A track record of fast growth
- Low dividend payout (So to reinvest into the company)
Value investing is a philosophy to guide us in the stock market. It teaches us to have a patience mindset and not be dragged into the endless speculations that happen in the market.
However, as investors, we would still need a strategy on how to manage our portfolio. Three of the more commonly used strategies in the market are:
- Deep value investing
- Dividend investing
- Growth investing
Which strategy do you think is your style? Let us know below.
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I prioritise dividend payment track record as it proves the businesses’ ability to crystallize profits into cash. And I advocate passive investing too, as I don’t favour looking at charts daily for indicators. Manage risk by having a portfolio of dividend yielding stocks of different industries to reinvest from time to time.