FFB-Post 5
Imagine collectors: some people collect stamps, others collect rare coins, and some even collect vintage cars. Each collection holds value and offers a sense of pride. Now, imagine having a collection of the most profitable businesses. That’s what investing is all about—buying and owning shares of profitable businesses in the stock market.
What Is Value Investing?
Value investing is about buying good businesses at good prices. It’s not enough to buy shares of profitable companies; you need to buy them at a price that offers value. Many investors fail to make money even when they buy shares of good companies because they purchase them at overvalued prices.
Origins of Value Investing
Value investing has its roots at Columbia Business School, where Benjamin Graham and David Dodd laid the foundation with their book, Security Analysis. They taught the principles of value investing, which include finding the intrinsic value of a stock and buying it at an undervalued price. This began in 1928, and some notable students of Graham’s class include:
- Warren Buffett (’51)
- Mario Gabelli (’67)
- Glenn Greenberg (’73)
- Charles Royce (’63)
- Walter Schloss (’78)
- John Shapiro (’78)
One invaluable resource for further reading is What Has Worked in Investing by Tweedy Browne, which details various successful investment strategies.
How to Calculate the Intrinsic Value of a Company
Calculating the intrinsic value of a company can be complex, but here’s a simplified approach:
- Understand Earnings: Look at the company’s earnings per share (EPS).
- Growth Rate: Estimate the company’s future earnings growth rate.
- Discount Rate: Choose an appropriate discount rate to reflect the investment’s risk.
- Calculate: Use the formula for discounted cash flow (DCF) or the Gordon Growth Model for a rough estimate.
Here’s a basic formula using the Gordon Growth Model:
Intrinsic Value = Expected Annual Dividend per Share /
Discount Rate – Dividend Growth Rate
This gives you a starting point to determine if a stock is undervalued or overvalued.
Embracing Value Investing
Value investing requires patience, discipline, and a keen eye for identifying undervalued opportunities. By understanding the true value of a business and purchasing its stock at a price lower than its intrinsic value, you set yourself up for potential long-term gains.
Looking Ahead
In future posts, we will delve deeper into the strategies of some of these great investors and explore how we can learn from their approaches. Value investing is a journey of continuous learning and disciplined decision-making.
Welcome to the world of value investing.
Stay tuned as we uncover more insights and strategies to help you become a successful value investor.
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