The Principles of Value Investing

I believe a long-term successful investment strategy requires guiding principles, which we'll explore today.

Adopting a principled investment approach ensures your actions reflect your thinking, as well as providing stability during market fluctuations. Adhering to these principles can greatly improve your investment success.

However, many investors, and all speculators, often disregard these fundamental truths, risking their portfolios as a result.

Society often values cleverness over principles that may appear mundane but have stood the test of time.

#1 - Think about stocks as pieces of businesses

Stocks aren't some kind of dot on a chart that flickers up or down. They are the rightful ownership to a company's assets and profits.

For example, if you buy a stock in a company like Apple, it's like you own a small part of Apple.

When Apple does well, makes cool new iPhones, and earns a lot of money, the value of your stock goes up. That's because you're part of Apple's success.

But it's not always smooth sailing. Sometimes, even big companies face challenges. Maybe they don't sell as many products, or something unexpected happens in the market. When that happens, the value of your stock can go down. It's all part of the business world's natural ups and downs.

So, owning stocks is really about being a part of a company's journey, sharing in its successes and its challenges. It's more than just numbers on a screen; it's a real stake in a real business.

#2 - Invest with a Margin of Safety

Notice, that in the first principle I did not talk about price, I was mentioning value only.

Let's look at the difference between the two through the concept of Margin of Safety:

As value investors, like the legendary Warren Buffett, we have a special way of picking stocks. We look for stocks that are like hidden treasures - good companies that are selling for less than they're actually worth. This is where the "Margin of Safety" comes in.

Think of it like this: You find a cool, high-quality couch that normally costs $500, but it's on sale for $400. The $100 difference is your "Margin of Safety." It's like a safety cushion. You're getting more value than what you're paying for.

In the stock market, the intrinsic value of a company is like the real, true value of that couch, considering how well it's made, how hip and how comfortable it is.

Sometimes, the stock market's price of a company can be lower than this intrinsic value – maybe people haven't noticed how good the company really is. We hunt for these situations.

We buy stocks where the company's true value (its intrinsic value) is higher than the current stock price.

This way, we reduce our risk of losing money and increase our chances of making a profit when other people eventually realize the stock is worth more and the price goes up.

It's like buying that $500 couch for $400 and knowing you got a great deal!

#3 - Use Mr. Market aka the bipolar stockbroker to your advantage

The term "Mr. Market" was made famous by Benjamin Graham, who's known as the father of value investing. It's a metaphor for the stock market.

Imagine Mr. Market as a kind of moody salesperson who shows up at your door every day with different prices for the same businesses.

Some days, Mr. Market is super optimistic and offers high prices because he's in a great mood.

Other days, he might be really pessimistic, maybe he's had a bad day, and he offers very low prices for the same stocks.

The key thing is, Mr. Market's mood swings don't change the actual value of the businesses he's selling.

As a smart investor, you use this to your advantage.

You don't have to buy or sell anything just because Mr. Market says so. Instead, you wait.

On days when Mr. Market is feeling gloomy and offers you stocks at really low prices – lower than what the companies are truly worth (their intrinsic value) – that's your chance to buy.

It's like getting a great deal on something you know is worth more.

On the flip side, if Mr. Market is overly excited and the prices are too high, you might choose not to buy or even to sell some of the stocks you own at these high prices.

The value investing approach relies on being patient and disciplined, waiting for the right opportunities when the market's mood swings work in your favour.

It's about making rational decisions based on a company's real value, not just going along with the crowd or reacting to the market's ups and downs.

#4 - Do your own research

Doing your own research is a crucial part of becoming a successful investor, especially if you consider yourself a value investor.

It's like being a detective.

You don't just rely on what others say or what you hear in the news. You dig deep to understand everything about the companies you're considering investing in.

This means looking at a company's financial statements, the management and its decisions, the company's competitive position in the market, and its future growth prospects.

It's like getting to know someone really well before you decide to partner with them for a venture. You want to know what makes the company tick, how it makes money, and what could affect its future performance.

Knowing your investments intimately is a key part of managing risk. It's like knowing the depth of the water before you dive in. You're less likely to be caught off guard by market fluctuations or unexpected events because you've done your homework.

This ties neatly into another important aspect: Independent thinking.

In the world of investing, it's easy to get caught up in what everyone else is doing or thinking - this is called "groupthink".

But remember, just because a lot of people are doing something, it doesn't mean it's the right thing to do. Having your own viewpoint, based on thorough research, helps you make smarter decisions.

It's like choosing your own path in a forest, rather than just following the crowd.

#5 - Stay within the boundaries of your Circle of Competence

Sticking to your circle of competence in investing means focusing on areas you understand well.

It's like playing a sport you're good at, rather than one you're unfamiliar with.

You don't need to be an expert in every field; it's better to invest in industries or companies you know and understand well. This approach helps you make better informed decisions.

For instance, if you're knowledgeable about technology, investing in tech companies might make more sense for you than venturing into industries like pharmaceuticals, which you might not understand at all.

It's also important to stay humble and recognize what you don't know.

The world of knowledge is huge, and no one knows everything. Being open to learning and cautious about stepping into unfamiliar territory can help you make smarter investment choices and avoid risks associated with areas outside your expertise.

Remember, sometimes the wisest investment decision is to not invest in what you don't understand.

One way to put these principles into practice