Warren Buffett, the wealthiest businessman and a talented investor, made much of his amazing fortune on value investing. Introduced by Benjamin Graham in the 1930s, the concept suggests buying and holding undervalued stocks. With time, the market sentiment alters and the true worth comes to the surface, bringing good returns.
But as any strategy, value investing has its benefits and traps.
The power of compounding. Value investing makes the most of the magnifying power of compounding. Your investments increase dramatically if you reinvest dividends and returns obtained from value companies. Thus, in the course of time, you benefit well from interest on interest. This is exactly what Warren Buffett holds dear, and we have reasons to believe him.
Reliable blue chips. Value investors consider the overall potential of a company, rather than shares and market sentiments towards them. They seek ownership in a well-established business that is able to make money and yield high earnings. As a matter of fact, value investing proponents prioritise sound and safe blue chips over small caps.
Value companies hide. Undervalued shares worth investing are difficult to identify. Estimating the intrinsic value requires a certain level of expertise and not every investor has it. Even if they do, there are a lot of things beyond investors’ control like changes in management and behaviour of peers. You can analyse all the fundamentals but there’s no guarantee you’ll make the right decision.
Patience. Value investing is not for everyone. Those who want to reap the benefits quickly may find it challenging. Sometimes proponents of this strategy have to hold their positions for years until the market sentiment changes in their favour. But in the end, patience may bring high reward.
The pitfalls of waiting. Having ownership in a value company can be fruitful, but it can equally be a dead end. Value traders can hold stocks for a lifetime but never see them turn around. In such a no-win situation, investors are forced to quit with a loss.
Rowing against the stream. Value investing requires self-confidence meaning that you’ll have to go against the flow. In a sense, value investors are very similar to contrarians. At least both of the styles are based on looking for price discrepancies and acting against the prevailing sentiment. Anyway, to see your investments bringing hardly any returns is quite a pressure.