What is Value Investing and How Does it Work?

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Last Updated:May 23, 2024

What is Value Investing and How Does it Work?

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If news about volatile stocks and stories like the GameStop stock short have you swearing off the stock market as having too much volatility to trust with your hard-earned money, it would be an understandable feeling to have. However, just because a few stocks went through an astronomical boom and bust cycle doesn’t mean all stocks perform that way. Investing in the stock market is still one of the most surefire ways to grow your wealth—assuming that you have a solid understanding of what you’re investing in and how you expect it to perform.

While many investors take a passive approach to investing, allowing the stocks they purchase to slowly grow in value over time, value investing (sometimes called “intelligent investing”) is a more active tactic. Investors such as Warren Buffet credit it as one of the biggest reasons for his massive wealth and cash flow.

Just because value investing is Warren Buffet’s go-to investment strategy doesn’t mean you need to be a financial genius to learn to value invest. Read on to get an overview of value investing and learn how to start making your own value investments in just a few short steps.

In this article

What is value investing?

While Warren Buffet, Charlie Munger, and Berkshire Hathaway are likely to ring more bells to you than the name Benjamin Graham, Graham is credited as the Father of Value Investing thanks to his book, The Intelligent Investor, which outlines a value investment approach.

In The Intelligent Investor, Ben Graham lays out a simple premise: an intelligent investor does thorough research before investing in a company, and that research hinges on what you believe a company’s intrinsic value is.

Before purchasing a stock, value investors look for investment opportunities based on whether they believe it is undervalued. Only purchasing undervalued stocks makes it possible to turn a profit since the share price you buy in at is lower than what you perceive the asset's true value will one day be.

Analyzing the market value is the main key to determining whether you’ll want to purchase any given stock for the short term or long term. The old phrase “buy low, sell high” rings true in value investing since if you buy a company at a low price with the belief that it will increase over time, you’ll make money if your valuation is correct and you sell at a higher price.

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How to get started

Value investing is simple as long as you have an analytical mind and a willingness to dig into and research a company’s past performance and future plans. Here are the three most important considerations to make as you get started value investing:

Research

The first and most important aspect of value investing is doing your research. If you get sloppy with your research, you may miss an important detail that clues you into whether or not it makes sense to invest in a company based on the valuation you calculate.

For example, let’s say that you looked at a company's stock that helped people buy discounted tickets in the live entertainment industry. During the Pandemic, that company’s value was likely to be relatively low since most people weren’t attending large, public gatherings like concerts or theatres. However, post-pandemic, the world is moving again, and eager to enjoy life, making it a great time to buy.

If the stock's current price is only $10, this may seem like a no-brainer to you. However, looking at other documents, such as balance sheets and even staff rosters, is important to ensure the company is in otherwise good health. For example, if the CEO is responsible for the previous four years of great performance left, buying it might be a bit more of a gamble — even at $10. That being said, if you learn that the company has hunkered down for the duration of the pandemic and has a solid amount of cash reserves on hand to tap and hit the ground running when it’s safe to do so, you may determine that there’s a high likelihood that company will perform well when it’s able to.

Beyond targeting companies with consistently positive performance for shareholders, it’s also a good idea to weigh other factors about them, such as their financial structure, plans for the future, and what team members have stayed consistent over the past several years. Short-term buzz may cause a small spike in a company’s stock; however, that bump in popularity is likely to be short-lived if the company doesn’t have the business acumen to build upon the increase in value.

It’s a good idea to identify whether or not the stock price offers a good margin of safety for you at its current value. Knowing that you expect the price to go up $20 gives you a wide enough margin of error that even if your calculations are off by $10, you can still make a solid return on your investment.

Diversify your portfolio

Like any other form of investment, it’s crucial to diversify your portfolio to protect yourself from market volatility. Investing in a mix of value, growth, and mutual funds can give you a competitive advantage by keeping you from relying too much on one stock’s performance to impact your net worth.

Beyond having your portfolio distributed across multiple kinds of securities, it’s just as important to diversify which value stocks you’re investing in. Spreading your investments across a few companies that you expect to offer good returns in the long run can be critical to mitigating your losses from volatility.

Don’t get greedy

Part of value or intelligent investing is picking consistent returns over the next hot stock. You will have a much better track record over the long run by seeking reliable returns rather than the potential for a massive spike or dip.

Taking a long view also ensures that your analysis is focused on a company’s long-term sustainability. Businesses like Apple and Amazon are sound investments because they offer their shareholders dividends repeatedly. Picking a company with a steady business plan rather than the next hot thing can be just as important as picking an undervalued company if you want to make money as a value investor.

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Costs and fees

Depending on which brokerage you use, fees may be associated with the transactions you make buying and selling stocks. These fee structures vary from brokerage to brokerage, so read up on your brokerage before making any value investments.

It’s also worth remembering that you should only invest money you can afford. Investing carries inherent risk, and no investment is guaranteed to offer you a solid return. Ensure you’ve budgeted for other monthly expenses before putting any money in the market.

Pros and cons

Pros

Can offer solid returns. A big benefit of value investing is that it can offer substantial returns, particularly if investing in a stock that is wildly undervalued.
Proven strategy. From hedge funds to personal investors, value investing strategies have been used for over 60 years to help investors make money in the stock market.

Cons

Requires active work. Unlike a passive investment strategy, you’ll need to put in time and energy if you want to see results as a value investor.
Learning curve. Unlike growth investing, which focuses more on selecting stocks based on their growth rate, a lot of research must be conducted about a company before you decide to value invest. As such, this territory definitely comes with a learning curve.

The bottom line

While value investing isn’t for everyone, it’s a sound investment approach that can ultimately offer great returns. Popularized by investors like Warren Buffett and Benjamin Graham and even hedge fund managers like David Abrams, value investing is a strategy that works.

By buying stocks at a value lower than their intrinsic value, you can find consistent returns as the general marketplace catches up to perceiving a company at its true value. That being said, a considerable amount of work needs to be conducted before making a value investment. If you’re not confident in your capabilities and financial research, finding a different approach to making money in the stock market may make sense.

Ultimately, it is important to find an investment strategy that works for you. Value investing is great if you like performing research and actively participating in your portfolio.

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Brent Ervin-Eickhoff is a Chicago-based writer, stage director, and filmmaker with a background in digital marketing and content creation. In addition to Joy Wallet, Brent has written for Complex, Volkswagen, HowlRound, Picture this Post, and Third Coast Review, among others. He currently serves as the Associate Director of Marketing for Content Creation at Court Theatre at the University of Chicago. Brent graduated from Ball State University with Academic Honors in Writing.

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