Value Investing

Buying good companies when they’re on sale

Understanding how to find underpriced stocks and invest like Warren Buffett
Modified

September 7, 2025

Category: Investment Strategy
Difficulty: Beginner

Definition

Buying stocks that cost less than they’re actually worth. Like finding a $100 bill selling for $60.

The Basic Idea

Value investors believe:

  • Markets sometimes get prices wrong
  • Good companies occasionally trade cheap
  • Patient investors can profit from these mistakes
  • Eventually, prices fix themselves

Think of it like shopping: You wait for sales on quality items rather than paying full price.

How Value Investing Works

Step 1: Find What a Company is Really Worth

Look at the business fundamentals: - How much money does it make each year? - What assets does it own? - How much debt does it have? - Is the business growing or shrinking?

Step 2: Compare to Current Stock Price

Ask the key question: Is the stock price less than what the company is worth?

Example: - Company worth $50 per share based on assets and earnings - Stock trading at $35 per share - Potential value investment (30% discount)

Step 3: Buy and Wait

  • Buy the underpriced stock
  • Wait for other investors to recognize the value
  • Sell when price reaches fair value (or higher)

Famous Value Investors

Warren Buffett

The most successful value investor ever - Started with $100,000 in the 1960s - Built Berkshire Hathaway into $500+ billion company - Average returns of 20%+ per year for 50+ years - Famous for buying Coca-Cola, Apple, See’s Candies

Benjamin Graham

The father of value investing - Taught Warren Buffett at Columbia University - Wrote “The Intelligent Investor” (1949) - Created the basic principles Buffett still uses - Focused on buying stocks below book value

What Value Investors Look For

Cheap Stock Metrics

Price-to-Earnings (P/E) Ratio - Stock price á annual earnings per share - Value investors want low P/E ratios - Example: P/E of 10 might be good value, P/E of 30 might be expensive

Price-to-Book Ratio - Stock price á book value per share
- Book value = company assets minus debts - Value investors like P/B ratios under 1.0

Dividend Yield - Annual dividend á stock price - Higher yields might indicate undervalued stocks - But watch out for dividend cuts

Quality Business Characteristics

Strong fundamentals: - Consistent profits over many years - Low debt levels - Strong market position - Good management team - Simple business model you can understand

Value Investing Strategies

Graham’s Net-Net Strategy

Buy stocks below liquidation value - Find companies trading below their cash and assets - Very conservative approach - Hard to find in modern markets - Focus on absolute cheapness

Buffett’s Quality Value

Buy great companies at fair prices - Focus on businesses with competitive advantages - Pay reasonable prices for quality - Hold for very long periods - Look for growing earnings and strong management

Why Value Investing Can Work

Market Psychology

Markets are driven by emotions: - Fear: Stocks get oversold during bad news - Greed: Popular stocks get overpriced
- Patience pays: Value investors wait for emotional extremes - Contrarian approach: Buy when others are selling

Business Reality

Good businesses eventually succeed: - Quality companies tend to grow over time - Strong fundamentals usually lead to higher stock prices - Patient capital gets rewarded - Market eventually recognizes true value

Value Investing Risks

Value Traps

Stocks that are cheap for good reasons: - Declining industries: Newspapers, brick-and-mortar retail - Bad management: Companies making poor decisions - High debt: Companies that might go bankrupt - Obsolete products: Businesses being disrupted by technology

Market Changes

Value investing doesn’t always work: - Growth stocks sometimes outperform for years - Markets can stay irrational longer than you expect - Technology has changed how businesses are valued - Interest rates affect value stock performance

Simple Value Investing Guidelines

For Beginners

  1. Start with value mutual funds - let professionals do the research
  2. Look for established companies trading at low valuations
  3. Check the P/E ratio - compare to industry averages
  4. Make sure the business makes sense to you
  5. Be patient - value takes time to be recognized

Red Flags to Avoid

  • Falling knife stocks - prices dropping rapidly
  • Too good to be true - extremely low valuations often have reasons
  • Complicated businesses - stick to companies you understand
  • High debt levels - avoid companies that might go bankrupt

Questions to Ask

  • Why is this stock trading so cheaply?
  • Is the business fundamentally sound?
  • Will this company still exist and be profitable in 10 years?
  • Am I buying because it’s cheap or because it’s good?

Getting Started

Value Stock Screening

Look for: - P/E ratio below 15 - Price-to-book ratio below 1.5 - Dividend yield above 3% - Consistent earnings growth - Low debt-to-equity ratio

Simple Value Strategy

  1. Screen for cheap stocks using basic metrics
  2. Research the business - read annual reports
  3. Start small - don’t bet everything on one stock
  4. Be patient - value investing takes time
  5. Stay disciplined - don’t chase momentum stocks

The Bottom Line

Value investing works by buying good companies when they’re temporarily unpopular. It requires patience, research, and the discipline to go against the crowd.

Warren Buffett’s advice: “Be fearful when others are greedy, and greedy when others are fearful.”

External Resources