Value investing capitalizes on the fact that there are profits to be made by purchasing low-priced shares of strong, but temporarily unpopular companies.
While this knowledge can lead to a relatively secure strategy for enjoying some solid portfolio returns, it’s important to become familiar with both the advantages and disadvantages of value investing in order to make the most of such a long-term investment approach.
Benefits of Value Investing
1. Value Investing is Not Exclusive to the Rich!
Regardless of your financial income, or your educational background, you can become a successful value investor.
One of the great things about value investing is that it’s fully accessible to anyone who is willing to work hard, and to invest the appropriate amount of time and patience.
As a matter of fact, patience is probably the most important factor in determining just how successful you will be as a value investor, since this strategy is all about waiting out short-term market fluctuations in order to benefit from long-term returns.
Beyond that, all you really need to make value investing work for you is an eagerness to learn, and the ability to access, read and understand a company’s fundamental information.
2. Makes the Most of Compounding
Value investing is an ideal way to take advantage of the power of compounding. When you reinvest the returns and dividends you earn from your value stocks, your profits grow exponentially over time.
In essence, your earnings will eventually begin to generate earnings of their own, with no extra work required on your part.
Don’t ever let yourself be fooled into thinking that your initial returns aren’t significant enough to make a difference over the long-term, since the beauty of compounding is that even the smallest amounts can increase dramatically when given sufficient time.
3. The Best Path to Stock Market Profits
Strategic value investing offers one of the best routes to profiting from the stock market.
By choosing stocks that are trading for less than their intrinsic value, but that are backed by financially strong companies with future growth potential, you can take advantage of an extremely effective way to earn high returns over the long-term.
Since value investing is based on picking solid stocks that are temporarily selling “at a discount”, it’s an investment strategy that gives you the chance to own relatively inexpensive shares of proven businesses, that are likely to bounce back and outperform the market down the road.
And not only is value investing less affected by short-range market dips than other investment strategies, you won’t lose any of your earnings to the various trading fees associated with moving in and out of short-term stock holdings.
4. Less Risk and Volatility
One of the biggest inherent advantages of value investing is that it’s subject to far less risk and volatility than most short-term investment strategies.
Because you’re not buying stocks today and selling them tomorrow, you don’t have to get caught up in the daily whirlwind of market price fluctuations. And you don’t have to spend your days monitoring the performance of your various stock holdings, since that performance revolves around a long-range strategy.
Long-term investing helps to reduce risk in your portfolio because attempting to time the profitable buying and selling of stocks over the short-term is one of the biggest contributors to investor loss.
The buy and hold strategy associated with value investing lets you avoid potential timing mistakes, since most of these are the result of hasty and emotional decisions, prompted by ever-changing market events.
Drawbacks of Value Investing
5. Requires an Investor’s Mindset
With value investing, there is no room for emotions. While this can make investing easier on one level, it can also be a challenging mindset to adopt over the long-term. As humans, we are prone to making decisions emotionally, and this often leads to our downfall as investors.
Adopting an investor’s mindset means eliminating the emotions of fear and greed from your decision-making process, and basing your actions on factual data rather than on gut feelings.
With value investing, the greatest investment you can make is in yourself and your financial education.
You must learn to efficiently analyze a company’s fundamental information, and to always follow the first rule of investing, which is: don’t lose money. And the second rule of investing is to never forget the first rule.
6. Hard Work and Patience is Needed
Value investing is not the easiest stock market strategy to implement, so you must be willing to do your homework to be successful.
Learning to evaluate a business requires both time and effort, and waiting to see the results of all your hard work will entail a great deal of patience. Watching your stocks rise in value can sometimes take years, and it’s not a very exciting process. This can present a very real challenge to those investors who crave the excitement of generating big returns, quickly. On most days, in fact, value investors will see very little change in the value of their stock holdings.
7. Intrinsic Values Can be Difficult to Estimate
Probably the biggest downside of value investing is the challenge of accurately estimating a company’s intrinsic value.
There are a number of different methods that investors can use to accomplish this task, but all of them require a certain level of expertise to master, and not every investor has a solid background in finance.
In determining how to value a stock, you’ll be looking at all the information that’s available about a given business, including its past and projected revenues, earnings, debt, and cash flows.
But even hard data such as these can’t always effectively account for such intangible and unpredictable factors as changing management styles and evolving market competition.
In the end, it will come down to your own skill in research, analysis and judgment for deciding whether or not a company’s stock is undervalued, and subsequently worth buying.
The Bottom Line
Fully understanding both the pros and cons of value investing before you buy your first stock will put you firmly ahead of the game.
Value stocks may never end up being the most exciting part of your investment holdings, but they can prove to be the most lucrative.
Buying on bad news and selling on good news might just translate into the best news of all for your investment portfolio.