IMAGINE YOU’RE GOING TO BUY A CAFE
The current owner tells you she wants $1,000,000 for it.
How do you know if that’s a reasonable price to pay?
You’ll probably look at a number of factors to help you work out how much you think it’s actually worth.
- How much profit does the cafe make each year?
- What kind of assets does the cafe own?
- What does it have in the way of debts?
- How long has it been operating?
- Are its profits consistently going up?
Value Investing asks similar questions of equities.
1. VALUE INVESTING IS A MINDSET
History shows that most people have no idea how to rationally invest in equities. They tend to make investment decisions based on two emotions – fear and greed.
“Did you hear about that hot new tech stock?! It’s gone up 500% in one year!”
“Better buy some!”
As Tony says, that’s not investing, that’s gambling.
Reduced to its fundamentals, value investing is quite simple. It’s about buying shares of companies that are temporarily undervalued by the market. The theory is that if the business does well, the stock will usually follow.
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2. HOW DO YOU FIND UNDERVALUED SHARES?
The discipline of value investing is to only buy shares that you deem to be temporarily undervalued by the market – and then holding them until the market catches up. Value investing tries to remove the emotion involved in buying equities and concentrates only on financial data.
The trick, of course, is knowing how to value a share.
We are looking for companies that have a history of strong financial performance (that is, they are consistently profitable) and whose shares are currently trading at a discount (that is, the share price doesn’t reflect the actual value).
3. SLOW AND STEADY WINS THE RACE
History shows that stock markets tend to go up about ten percent per year on average.
Warren Buffett, has achieved a 19.7 percent average annual return over 48 years, and considers himself very low risk – one of his most famous sayings is “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” So 19-20 percent per year seems like a reasonable low risk benchmark to aim for.
Those kinds of returns aren’t going to make someone rich quickly – but they compound over time. Value investors are content to take their low risk 19-20 percent annual growth and let it compound over a long time frame.
4. HOW DO I LEARN VALUE INVESTING?
A good place to start would be to read the books listed here.
The QAV Value Investing checklist is the result of Tony’s study of the world’s best value investors over 25 years. It’s his quick way of assessing the quality and value of companies on the ASX (the Australian Stock Exchange) but the same process works on other exchanges. We know of people using our checklist in the USA, Canada, New Zealand and Switzerland.
If you want to learn how to use it properly, check out the first couple of episodes of our popular Australian investing podcast.