In the field of investment, short-term performance is often influenced by market luck, leading to volatile returns. In the short term, there will always be winners and losers in the market, but long-term winners are markedly different. This distinction is key to understanding the core issue of value investing: Is it luck or skill that determines long-term success? Value investing demonstrates its sustainability across various markets, showing a unity of temporal breadth and strategic depth. This approach, first introduced nearly a century ago by Benjamin Graham, has its most notable contemporary proponent in Warren Buffett.
Origins of Value Investing and Its Modern Leaders
The concept of value investing was introduced by Benjamin Graham in the early 20th century. Known as the “father of value investing,” Graham’s principles are still widely applied globally. In his seminal works, Security Analysis (1934) and The Intelligent Investor (1949), Graham systematically outlined the theory and practice of value investing. These books remain classics in the investment field.
Warren Buffett, one of the most prominent advocates of value investing, studied under and befriended Graham. Buffett inherited and expanded upon Graham’s ideas, achieving extraordinary returns through this investment strategy and earning immense respect in the global investment community. Buffett’s company, Berkshire Hathaway, epitomizes the principles of value investing, and his success story and investment philosophy are widely taught and emulated. Buffett has not only perpetuated Graham’s core ideas but also infused them with his unique insights, making him the epitome of modern value investing.
Four Basic Principles of Value Investing
Stocks Represent Ownership in a Company The first core principle of value investing is viewing stocks as certificates of ownership in a company rather than mere tradable securities. This reflects the essence of stocks as investable assets. Value investing emphasizes that stocks signify partial ownership of a company. Investing in stocks means investing in a company, not just in a market price fluctuation.
From this perspective, investors analyze the intrinsic value of stocks based on the company’s fundamentals, not short-term market movements. In a growing economy with rising corporate profits, companies can create more value, and shareholders benefit from the appreciation of their holdings. Therefore, value investing is not just about trading stocks for profit but about supporting the company’s growth and sharing in the value it creates.
This investment approach is sustainable because the returns investors receive are natural rewards from the company’s value creation. Unlike speculative strategies that rely on short-term market movements, value investing focuses on a company’s long-term development and intrinsic value, thus achieving stable and enduring returns.
The Role of the Market The second core principle is understanding the market’s role. The stock market is not just a place to trade securities; it is a mechanism that provides buying and selling opportunities. Market price fluctuations reflect short-term supply and demand, not the company’s true intrinsic value. In this market environment, value investors should see the market as a tool for trading opportunities, not a standard for judging company value.
The market offers opportunities to buy and sell when prices deviate from intrinsic value. When market prices are below a company’s intrinsic value, investors can buy stocks; conversely, when prices are above intrinsic value, they can sell. Therefore, value investors should use market price fluctuations as a tool to discover investment opportunities rather than being swayed by short-term price changes.
The Nature of Investment and Margin of Safety The third core principle is that investment involves predicting the future. Given the inherent uncertainty of the future, no prediction can be 100% accurate. Therefore, value investors need to establish a margin of safety to mitigate risks from prediction errors. The margin of safety means buying stocks at prices significantly below their intrinsic value to minimize potential losses if predictions are incorrect.
Even with a 90% confidence in an investment, the 10% uncertainty must be considered. Investors should set a sufficient margin of safety to ensure that losses are effectively controlled if the market changes unfavorably. This cautious approach helps maintain stable investment decisions in the face of future uncertainties, achieving steady long-term returns.
Circle of Competence and Market Perception The fourth core principle is the circle of competence. Buffett introduced this concept, which refers to areas or industries where investors can make more accurate judgments and analyses than most people. Investors should focus on fields they are familiar with and understand, thus forming their circle of competence.
The essence of the circle of competence is knowing its boundaries. Only by understanding one’s limits can investors avoid blind and erroneous decisions in the investment process. The market reveals investors’ psychological and knowledge weaknesses. Successful investors operate within their competence circle, making informed and accurate analyses to reduce investment risks.
Practical Strategies for Value Investing
Company Financial Analysis Investors need to conduct an in-depth analysis of a company’s financial status, including its balance sheet, income statement, and cash flow statement. These financial statements reflect the company’s operational health and financial condition. By analyzing these data, investors can understand the company’s profitability, debt levels, and cash flow, thereby assessing its intrinsic value.
Evaluation of Management A capable management team is crucial to a company’s success. Investors can evaluate the management team’s abilities and integrity through publicly available information, past performance, and industry reputation. A competent management team can lead the company to profitability and make wise decisions when facing market challenges, ensuring the company’s long-term development.
Industry and Market Environment Analysis Different industries have varying prospects and market risks. Investors need to understand the current state and future trends of the industries they invest in. Additionally, macroeconomic conditions, policy changes, and market competition can impact a company’s operations. By analyzing the industry and market environment, investors can more accurately assess the company’s growth prospects and investment risks.
Investment Portfolio Management Investors should allocate their portfolios based on their risk tolerance and investment goals. They can diversify investments across different industries and companies of various sizes to mitigate risks. Investors should also regularly evaluate and adjust their portfolios in response to market changes and company developments. Effective portfolio management helps maximize returns while minimizing risks.
By understanding and applying these principles and strategies, investors can navigate the complexities of the market and achieve sustainable long-term gains through value investing.
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Company: New World Asset Management Ltd
Founder: Don Adam Perera
Product: AI New World Wealth 4.0
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