Value Investing: Tools, Techniques, and Strategies

Last Updated – Sep 1, 2023 @ 4:24 am

Investing can seem complex and intimidating, especially for beginners. The amount of information, strategies, and advice available online can leave you feeling overwhelmed and unsure of what to do or where to start.

But fear not. There’s a proven and tested approach that has stood the test of time: value investing.

Whether you’re a beginner or you already have basic financial knowledge, value investing offers a sensible, simple, and approachable way to build wealth.

In this guide, we’ll explore the tools, techniques, and strategies of value investing to help you get started on your investment journey.

What is Value Investing?

Value investing is an investment strategy that involves buying stocks or other financial instruments that are undervalued by the market. What this means is that the market price of the stock or asset is lower than its intrinsic value, which is the true value of the stock.

Think about it this way: If you buy something on sale, you’re getting more value for your money. Value investing works the same way – you’re buying into companies that are priced lower than their actual worth, giving you a better return on your investment in the long run.

Investors who practice value investing look for companies that have strong fundamentals but are overlooked due to short-term market fluctuations or other factors.

The goal is to buy these stocks at a discount, hold onto them, and ultimately reap the benefits of their potential for growth and profitability.

This requires a disciplined and patient approach to investing, as well as a willingness to do thorough research and analysis to identify promising investment opportunities.

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What makes a great value stock?

A good value stock is one that is currently undervalued by the market but has a strong potential for long-term growth.

So what does this mean? 

The company should have solid financials, a competitive advantage, and a clear path for future success.

To identify these stocks, investors must look beyond the short-term market fluctuations and focus on factors such as the company’s financial health, competitive advantage, and its short and long-term growth prospects.

1. Financial Health

The financial health of a company can be measured by a company’s balance sheet. A company with a healthy balance sheet has more assets than liabilities, indicating that it has the resources to pay its debts and invest in growth opportunities.

2. Competitive advantage

Competitive advantage is another important factor to consider when it comes to looking for a great value stock.

A company with a strong competitive advantage has a unique product or service that gives it an edge over its competitors. This could be in the form of a patented technology, a strong brand, or a loyal customer base.

3. Growth Prospects

Finally, growth prospects are crucial to the success of a company. Look at factors like revenue growth, earnings growth, or market share expansion.

A company with strong growth prospects is more likely to see an increase in stock price over time, making it an attractive investment opportunity for value investors.

That said, it’s recommended (especially for beginners) to focus on companies that have a well-established history and a proven track record of success and stability to reduce risk.

Related: Stock Trading & Investing Guide in the Philippines

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Foundational Principles of Value Investing

To better understand the foundational principles of value investing, let’s take a closer look at some of the key concepts that guide this investment strategy.

Intrinsic value

At the core of value investing is the concept of intrinsic value. This refers to the true value of an asset, which is often different from its market price.

The goal of investors who practice value investing is to identify assets that are undervalued by the market and hope that their true value will eventually be recognized and reflected in the asset’s price soon enough.

To determine intrinsic value, value investors use a variety of analytical tools and techniques such as financial ratios, discounted cash flow analysis, and comparative analysis.

By comparing a company’s intrinsic value to its market price, investors can identify potential buying opportunities and make informed investment decisions.

Fundamental Analysis & Valuation Techniques

Fundamental analysis involves analyzing a company’s financial data and industry trends to determine its real market value.

Meanwhile, valuation techniques such as price-to-earnings ratio (P/E ratio), price-to-book ratio (P/B ratio), and discounted cash flow (DCF) analysis are used to determine whether a company’s stock is undervalued or overvalued.

This will be discussed further in the next section.

Margin of Safety

Coined by Benjamin Graham and David Dodd, the pioneers of value investing, the margin of safety acts as a protective cushion for investors.

It ensures that the risks are minimized and ensures that the price you pay for a stock is truly lower than its intrinsic value.

This acts as a safety net in case the market remains unstable, the company experiences a temporary setback, or if your assumptions turn out to be incorrect.

Contrarian investing & avoiding herd mentality

Serious value investors do not follow the popular opinion or trends in the market. Instead, they seek out opportunities that others may have overlooked.

Keep in mind that market sentiment is usually driven by short-term news and events, leading to fluctuations in stock prices that do not accurately reflect the long-term value of a company.

By taking a contrarian approach, value investors can identify undervalued companies better.

Long-term perspective

You must be patient and willing to hold onto your investments for an extended period of time, often years.

After all, it may take time for the market to recognize the true value of an undervalued asset, and for the company to grow and realize its potential.

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Value Investing Tools and Techniques

Let’s dive into some of the tools and techniques that value investors use to analyze and identify potential investment opportunities.

Fundamental Analysis

Fundamental analysis is a technique used by value investors to examine a company’s financial and economic standing.

This includes understanding its financial health, profitability, and cash flow by studying the following: 

Balance sheets

The balance sheets of a company provide insight into its assets, liabilities, and equity. Look at the trend of these ratios over time to see if the company is improving or deteriorating financially.

Income statement

Meanwhile, the income statement shows the revenue and expenses of the company over a period of time.

A value investor must assess the annual revenue growth and profit margins to see if the company is generating income and improving its profitability.

Cash flow statement

This provides information on the company’s cash inflows and outflows, as well as how it manages its working capital.

Value investors must assess the company’s ability to generate free cash flow, and how it uses that cash to invest in growth opportunities or return value to shareholders through dividends or share buybacks.

Qualitative Analysis

This refers to the analysis of non-financial factors that can affect a company’s performance.

Management quality

A strong management team can effectively execute the company’s strategy, make sound financial decisions, and navigate through challenging times.

To evaluate management quality, consider factors such as the experience and track record of the company’s top executives, their communication with shareholders, and their alignment with shareholder interests.

Competitive advantage or “moat”

This is an important factor for value investors because a company with a strong moat is likely to have stable profitability and sustainable growth.

This could be in the form of a superior product, loyal customer base, or great social media presence, among many others.

Industry dynamics

Value investors must take time to understand the industry’s competitive landscape, the regulatory environment, and any macroeconomic factors that may affect the industry because the success of a company is heavily influenced by industry trends and dynamics.

If the industry is declining, even a well-managed business may struggle to stay afloat. On the flip side, a company operating in a growing industry may experience significant growth and success.

Valuation Metrics

Take a look at the valuation metrics that value investors use to determine the intrinsic value of a company.

Price-to-book (P/B) Ratio

This measures the value of an asset and compares it to its stock price. If the price is lower than its value, then it means the asset is undervalued (if the company is not facing financial troubles).

Price-to-Earnings (P/E) Ratio

This shows the track record of companies for earnings. A low P/E ratio means that the stock’s price is relatively low compared to its earnings. This could mean that the market is undervaluing the company.

Dividend Yield

The dividend yield is the annual dividend payment divided by the stock price, expressed as a percentage.

This metric is important to value investors because it helps them assess any company’s ability to generate cash flow and return value to shareholders.

A high dividend yield could indicate that the company is undervalued and has strong cash flow, while a low dividend yield may suggest that the company is not generating enough cash flow to support dividend payments.

Debt-To-Equity Ratio

This ratio measures a company’s debt compared to its equity.

Too much debt can be a red flag for value investors since it may mean that a company is at risk of defaulting on its debt obligations or may have difficulty financing future growth opportunities.

On the other hand, a lower debt-to-equity ratio shows that a company is using less leverage to finance its operations. This can be seen as a positive sign for value investors.

Discounted Cash Flow (DCF)

The DCF model estimates the value of a company based on its expected future cash flows and discounts them back to their present value using a discount rate which accounts for the risk and time value of money.

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Value Investing Strategies

Here are some value investing strategies that you can implement.

Deep value investing

Deep value investing is a strategy that involves investing in companies that have been severely undervalued by the market.

Growth at a Reasonable Price (GARP) Investing

Value investors using this strategy will typically look for companies that have growing revenue and earnings but are still trading at a reasonable valuation.

Contrarian investing

This refers to investing in companies that are currently out of favor with the market.

This strategy is based on the idea that the market can be irrational in the short term, and that companies that are currently unpopular may present long-term opportunities for value investors.

Dividend Investing

Dividend investing is a strategy that focuses on investing in companies that pay regular dividends to their shareholders.

This can provide a steady stream of income for investors, particularly those who are looking to generate passive income from their investments.

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Best Investments for Value Investing in the Philippines

Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value.

It’s worth noting that pinpointing the “best” investments is highly subjective and can vary based on market conditions, economic factors, and individual business performances.

Here are some of the sectors that have traditionally been of interest for value investors in the Philippines:

1. Blue-Chip Stocks

These are shares in well-established companies with a history of generating profits.

In the Philippines, blue-chip stocks often belong to the Philippine Stock Exchange Index (PSEi), which includes companies like Ayala Corporation, SM Investments Corporation, and BDO Unibank.

2. Banking & Financial Services

Banks like BDO Unibank, Metrobank, and Bank of the Philippine Islands (BPI) have traditionally been stable performers.

Look for banks with strong fundamentals, steady profit growth, and a good dividend payout.

3. Property Sector

The property sector, including giants like Ayala Land, SM Prime Holdings, and Megaworld, might provide good value, especially if they have a lot of undeveloped land in their portfolio or are involved in lucrative segments like BPO office spaces.

4. Utilities & Infrastructure

Companies in the utilities sector, such as Metro Pacific Investments and Meralco, or water providers like Manila Water and Maynilad, can provide steady dividends and stable growth due to the essential nature of their services.

5. Consumer Goods & Retail

Given the Philippines’ consumption-driven economy, companies in this sector can be a good bet. Look at companies like Universal Robina Corporation, Jollibee Foods Corporation, or Puregold.

6. Diversified Conglomerates

Companies like San Miguel Corporation, Aboitiz Equity Ventures, and GT Capital have diversified interests across multiple sectors, which can spread risk.

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How to Find Value Stock

Finding value stocks requires careful research and analysis. First, start by studying tons of companies that you think have potential.

Remember the factor metrics listed above to identify undervalued companies. For instance, it should have low P/E ratios, high dividend yields, and low debt-to-equity ratios.

Additionally, look for stocks that are usually traded lower compared to their competitors and are less volatile than other stocks (not applicable all the time).

Once you’ve identified a potential value stock, conduct thorough research on the company and its industry.

Practice fundamental analysis and look at the company’s financial statements to get a better picture of its financial health and potential growth prospects.

Finally, analyze the company’s competitive landscape and industry dynamics to better understand all potential risks or opportunities.

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Why Stocks Become Undervalued

We’ve listed some of the most common reasons why stocks may become undervalued:

The market is down

During market downturns, many stocks may experience a decline in price, even if the companies themselves remain financially stable.

Company-specific issues

Sometimes, a company may experience issues such as a temporary downturn in earnings or a negative news event that causes its stock price to drop.

While these issues may be temporary, they can create an opportunity for value investors to buy into the company at a lower price than its intrinsic value.

Herd mentality

Investors may sometimes exhibit a herd mentality, following the trends and buying or selling based on the actions of others rather than independent research.

This can lead to stocks being undervalued due to a lack of attention or popularity in the market.

Bad press/news

Negative news or press can cause a company’s stock price to drop, such as a public relations disaster.

While these events can be damaging in the short term, they may not necessarily reflect the long-term potential of the company

Cyclicality

Some stocks may become undervalued due to cyclicality in their industry. For example, companies in the energy sector may experience a decline in stock prices during periods of low oil prices.

Not on people’s radars 

These companies may be lesser-known or operate in niche markets, but may still have strong fundamentals and growth potential that have yet to be recognized by the broader market.

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Benefits of Value Investing

Want to know why value investing is a popular strategy among investors? Here are some of its benefits.

Long-term investment horizon

Unlike short-term traders who chase after hot stocks, value investors focus on the long-term potential of a company and its ability to generate sustainable returns for shareholders without much active effort.

Reduction in speculative risks

Value investors reduce their exposure to speculative risks associated with short-term trading or investing in overhyped stocks.

This allows for a more stable investment portfolio that can weather market volatility and downturns, as well as avoid uncertain degrees of loss.

Potential for significant undervalued gains

By purchasing stocks that are trading below their intrinsic value, value investors are able to buy low and sell high, therefore realizing gains that can significantly exceed those obtained through other investment strategies.

Outperform inflation

Value investing can provide a hedge against inflation because of its potential high returns, coupled with the power of compounding effect.

Aside from protecting and growing your wealth over time, it can also generate a steady stream of income through dividends.

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Risks with Value Investing

Just like other investment strategies, value investing also carries risks that investors should be aware of, such as:

Long-term horizon

Long-term horizon is a double-edged sword. When value investors aim to hold onto their investments for the long term, they may miss out on short-term opportunities that could have generated higher returns.

Additionally, long-term investments may be subject to drastic shifts in market trends or changes in the company’s industry that could negatively affect their returns.

Value traps

Investors may fall into the trap of buying stocks that appear undervalued but end up being overpriced due to underlying fundamental issues or trends.

This can result in significant losses for investors who did not conduct thorough research and analysis before investing.

Limited diversification

Value investors may focus too much on a few select stocks, which can lead to limited diversification in their portfolio.

This can increase risk as a single negative event could have a significant impact on their overall returns.

Needs a lot of research and analysis

Value investing can be time-consuming and may require specialized knowledge about the industry or sector in which the company operates.

Not only that but it may be difficult to find value stocks that meet all the necessary criteria for investment.

Lack of liquidity

Some undervalued stocks may have limited liquidity which can make it difficult for investors to buy or sell their shares at the price they want if they need cash fast.