You may have heard that the way A LOT of billionaires became billionaires was through an investment strategy called “Value Investing”.
This is an interesting way to invest in stocks in the stock market or in actual fact to make any investment at all.
It is also pretty easy to explain and even easier to understand.
Essentially the strategy is about researching a stock, in the case of using value investing in the stock market, and trying to discover its true value.
The true value of the stock is called its intrinsic value and is what a share in the company you are researching actually is worth.
So let’s say for example we are researching Walmart stock (ticker: WMT) we see that it is currently trading at $93.
However in our research we actually value a share in Walmart closer to $130 because we have identified many factors that will cause the stock to grow.
And this is what we call Value.
We can see that we can buy a share in Walmart for $93 when we have calculated its true intrinsic value to be $130.
Which is good because this brings us to the next key part of value investing strategy.
The Margin of Safety.
A margin of safety is essentially a way of ensuring that we do not lose money in our investments.
We factor in that although we have calculated Walmart stock to be worth $130 actual value.
We understand that there could possibly be outside uncontrollable factors that could cause it to not reach this amount.
And so we put in a margin of safety and say that we need to have a value to current stock price divide of at least 20% and this is our margin of safety.
So for the example of Walmart stock we see it as a $130 intrinsic value, currently trading at $93.
$26 is our margin of safety, still leaving an easy profit of $11 per share — even if our entire margin of safety is used up on an unexpected factor.
Some unexpected factors that could cause the stock to decrease are things like missed earnings for a quarter.
Yet by calculating the intrinsic value of the stock, and then factoring in a margin of safety, even if something like that did happen causing the stock to not reach its full true value…
We are still profiting $11 per share.
So if we purchased 100 shares we’re still making a tidy profit off this trade of $1,100.
Of course if everything does go right and the stock does reach its real value, we are making $37 per share.
So with 100 shares we’re profiting $3700, before taxes and trading fees.
So that should give you a brief understanding of how value investing is applied to the stock market.
It is exactly how some of the richest men in the world made their billions. People like Warren Buffett, Seth Klarman and David Einhorn, all made their billions value investing.
Yet I like to take the concept of value investing and apply it to almost every investment decision I make.
Even if I am starting a new website or online business I like to look at it from an investment standpoint.
What do I expect to get return wise from my investment in this business I am going to create?
What happens if everything does not go as planned? Can I still make money?
I factor in a margin of safety into all my investments, whether I am investing money, or just time and energy.