Stock Market Investing - Value Investing(Old way)

Value investing is a concept that was brought to light by Warren Buffet by following the principles of Benjamin and Graham. This article would provide an overview of the old way of value investing strategy.

Its extremely important that you understand what you pay for a business. And you can make that determination only when you know the value of a business. What you see in the market is the price of a business at given point based on sentiments of investors.

Discounted Cashflow method is used by famous investors to find the the intrinsic value of the business. Look at a companies record and project the free cash flow of the company in years to come and assign a terminal value for the company and discount the business value for investment today. Intrinsic value calculation can vary a lot based on the assumptions and required returns expected by the investor. Hence you cannot determine the value of a business to dot. You should always consider an error margin and look at the value as a range (+-X% of Intrinsic value).

You can get a detailed explanations and spreadsheet templates online. Here is one of the video with detailed explanation on how to value a business.

After you have analysed a set of businesses in a given sector you would be in a position to get this number close to whats the value of the business might be today. And if there are bargains which are way below your intrinsic value range then a value investor would buy those and wait for it to get fully priced. This is value investing; these companies will have favorable metrics like low P/E, low P/B etc.

"Buy something thats cheap (say 30 cents) when the business should be worth a dollar". You can identify such companies and pocket a bunch of those and let it get rerate itself. In most cases the market would catches up to your valuation over the long run. As a value investor (old way) you would move out when its fairly priced (when its gets closer to a dollar). Then you look for the next business to own.

This process of buying cheap stocks and selling then at a fair price was the process followed by Buffet and other great value investors in their early days of investing. Now these value investors have changed their strategy as the old way has some drawbacks.

Here are some of the drawbacks

• Cheap companies are cheap for a reason and they might not have a favorable runway.Often referred to as "cigar butts" by Warren (May be just a puff left in them).

• Finding an misprized company is hard these days as a lot of work is done to build screeners to analyze such opportunities.

• Selling a company and looking for another opportunity to deploy the capital in current exuberance market is difficult.

• You would have to pay taxes on your profits, every time you sell and buy - its not an efficient way to grow your wealth.

In the next article we will look at the new way of value investing thats adopted by the great investors.

Disclaimer: The article is my opinion and is not meant as a investment advice. Please do you own investment research and follow approach that suits you best. Good luck!