Don't forget to rate the articleValue investing is a bit like Cinderella's story - about a girl who actually had
it in her and rose from the cinders to be queen. It is based on the contrarian premise
that the stock market is less efficient than people think. To the value investor, the
Street is populated largely by herd-instinct types. They're too busy running after the
latest trend to notice unglamorous companies whose comparatively low share prices don't
fairly reflect positives like current profitability or bright future prospects.
Almost all fund managers at least pay lip service to the concept of value, and will
mention its code words -- on the lookout for stocks that are "bargains,"
"cheap," "overlooked" and/or "undervalued." It would be a
rare -- and short-lived – manager indeed who claimed to favor stocks that are selling
for more than they're worth, or companies sure to be headed for a decline. Even some
aggressive growth players claim to be seeking "value-growth" issues, or
"growth at a reasonable price." Likewise, even the most value-oriented fund
managers prefer a stock that has at least some potential for growth.
Value money managers like Buffett, Gabelli and others have written extensively about their
methods on value investing and have made millions from this approach. A fund manager who
believes in picking stocks that are moving up fast in the hope of selling them at the
right time is following a momentum strategy. A fund manager who invests in companies with
high P/Es and high expected growth rates follows a growth investing philosophy. Against
this, the one who buys companies with low P/Es is following a value investing philosophy.
The one who analyses stocks on the strength of their fixed assets is said to have an asset
play approach. A fund manager who believes in buying stocks that are currently out of
favor or is selling the popular stocks has a contrarian value-approach.
A value stock is stock in a company that is relatively cheap compared to its earnings or
"book value" (mostly tangible assets -- planes, trains, and automobiles, and
buildings and machinery). Value stocks tend to be stodgy players in slower-growing,
defensive or cyclical areas. In contrast, a growth stock means a share of a company that
is relatively expensive compared to its current earnings or assets. Investors buy an
expensive growth stock, or bid it up to expensive levels, because they expect the company
to grow. Growth stocks tend to have a high price relative to current earnings, and provide
little if any dividend, because investors expect the stocks to show above-average growth
in earnings and/or sales. This belief is usually founded on a history of growing earnings
or sales, or on the company's being in a promising, high-growth sector (technology,
biotechnology, developing communications).
Now for the fairy godmother stuff: In the long run, value stocks have tended to outperform
growth stocks. After all, an under-performing company simply has to defy people's low
expectations, while a growth stock has the more difficult task of meeting the sometimes
stratospheric expectations with which the market has burdened it. Many experts have the
opinion that the location and realization of value shares in stock markets is based more
on taking advantage of market perception than of any concept of "real" value. A
share is undervalued, using fundamentals as the indicator, because the market has
permitted that undervalue to exist. It shouldn't, in theory, but because things are not
perfect it does. It has opined at that moment that the value, as dictated by the current
price, is lower than the value investor's own perception based on an analysis of the
fundamentals. The investor cannot, though, profit from what he sees as an incorrect
perception by the market until the market decides that it should change its perception of
the share by according it a higher price - and that is where value investing comes in.
The danger with the value-investing approach is that, what appears to be gold may indeed
be little more than fairy dust -- OK, angel dust at this level. And even if that
undervalued company remains a solid money-making enterprise, investors too dreamy eyed to
see it today could be just as unperceptive tomorrow. In 1999, Internet stocks were the
most extreme example of growth stocks. So far in 2000, biotech wears the emperor's new
clothes. Wise investors should look for value. That may sound at once obvious and a tad
old-fashioned. After all, value investors--those down-to-brass-tacks types who follow
time-honored rules for investing in companies with hard assets and cheap stocks--haven't
done especially well in the '90s. Meantime, their growth-oriented brethren have been taken
on a spectacular ride as ever-rising profits catapult high-tech companies forward.
But value investing--updated for the New Economy -- may once again offer investors good
returns, the tools to identify and search out value. First, check out how to define value
investing. Don't think it means just applying the sharp-penciled analysis to identify
promising but stodgy underperformers. The new value analysis gets beyond the glitz of New
Economy stocks with sky-high price-earnings ratios. It shows some of these stocks to be
unstoppable brands with huge market penetration and ample cash flow, or value—and
plenty of it. Investors can also try to lock in value by unearthing some of the small and
mid-cap stocks whose earnings potential is good and not yet fully recognized
With the market the way it is at the moment-value investing seems to be the norm of the
day. Don't get carried away by the "herd mentality" of selling now-keep your
head and pick up stocks which are a combination of value and growth. Sectors like
infotech, pharma, telecom, cables, paints and may be even cement merit an investment and
remember the saying that when the shoe shine boy starts giving you tips, its time to get
out of the market-now we are adding to this, that the best time to buy is when everyone
else is selling!