There are a number of investment strategies in the stock market that have proven to be very successful for investors. Value investing has proven to be one such strategy. It has generated massive wealth for many investors over the years.
One of the biggest followers of this is legendary investor Warren Buffet. He has been known to be a big advocate of value investing and has made a lot of money following the strategy.
“Price is what you pay. Value is what you get.” -Warren Buffett
Let's understand the basic principle of value investing.
Simply put, value investing is a strategy where the investor buys stocks that are undervalued by the market but have huge growth potential. The investor holds the stock for a long period of time, till its stock prices appreciate and reaches their fair value.
As the stock has been bought at a discount, the investor gets massive returns when sold at fair value. Even though such stocks are undervalued by the market, they are backed by very strong fundamentals.
Value investors do not get concerned by near-term price movement in the stock or even market volatility. They believe that the market is overreacting and that the sudden movement will have no long-term bearing on the stock since its fundamentals are strong. However, such investors use this time to pile up on value stocks and then hold on to them till it reaches their full potential.
How to identify a value stock.
At a specific time in the market, stocks can be overvalued, or undervalued. Investors use technical tools like price to earnings ratio, price to book ratio to figure out when a stock is overvalued and undervalued.
A low P/E ratio and P/B ratio showcases that the stock is undervalued at that particular time.
Along with strong fundamentals, value investors also look for stocks with low debt and prefer ones that have given consistent dividends over the years.
Let's look at some other key things value investors must keep in mind:
1) It is important to avoid herd mentality. Just because a number of investors are buying or selling a stock, it doesn't mean you should. Even if the stock has seen recent losses but if its fundamentals are strong and you believe it has good growth potential, it may be worth holding on to. Do not sell just because everyone else is. Similarly, if a stock is in demand, but does not have excellent fundamentals, you can skip it.
2) It is very important for value investors to have a margin of safety. It is not always necessary that the stock you choose is the right one. So it is important that you have a safety margin so you can protect yourself from losses.
3) It is very necessary for a value investor to understand the business of the company. If you do not, it will not be possible for you to properly analyse its fair value. He/she must look at the firm's long-term plans, management efficiency, past performances, capital structure, etc.
Now that we have a basic idea of value investing and how to identify such stocks, brokerage house Samco securities have come out with a list of value stocks for you to invest in 2021.
Sonata Software: As per the brokerage, the firm has achieved substantial and sustained growth in revenue and profit – CAGR of over 17 percent in the 5 years. In addition to this, Sonata has had a payout ratio of nearly more than 50 percent in the past 8 years maintaining a robust financial risk profile.
Avanti Feeds: "The company operates with the best financial risk profile of zero-debt and has stated the cash generated from operations will be sufficient to satisfy the foreseeable capital expenditure and working capital requirements in future," stated the brokerage.
Gujarat State Petronet: "GSPL operates with an open-access model which supplements healthy profitability for the company. The Company also has a majority stake in Gujarat Gas Ltd. which is India’s largest city gas distribution company in its kitty. GSPL has a 2,620 km long pipeline network which is the second-largest gas transmission pipeline network operator in the country, after GAIL. Further, its capital structure was comfortable with an overall debt to equity ratio of 0.24 as of March 31, 2021," noted the brokerage.
Oracle Fin: "Oracle has established an extensive global presence across leading markets through its sales and marketing network. Its topline has grown at a CAGR of 4 percent and the bottom line has grown at a CAGR of 11 percent over 5 years. The company operates with the best financial risk profile of zero-debt and has stated the cash generated from operations will be sufficient to satisfy the foreseeable capital expenditure and working capital requirements in future", explained the brokerage.
Mphasis: "Its financial profile remains healthy marked by stable earnings, sizable net worth, and strong liquidity with large cash reserves, healthy capital structure and coverage metrics. The revenues grew by 9.94% YoY during FY2021 which was supported by higher-order executions and new deal wins. Mphasis’ operating margins have remained at 19% in FY2021 aided by the enhanced scale and operating efficiencies. As of March 2021, the company’s cash and cash equivalents were robust at Rs. 1,062 crore," the brokerage said.
Pidilite Industries: "Financial risk profile is marked by a healthy net worth of Rs. 5,593 crore as of March 31, 2021, and debt to equity ratio of 0.06. Debt protection metrics remained strong with interest coverage of about 42 times. Networth is expected to improve further, led by healthy accretion to reserves over the medium term," it pointed out.
While these stocks can prove to be valuable in the future, some stocks like Alkyl Amines, Deepak Nitrite, Bharat Rasayan, Bajaj Finance, Vaibhav global have already proven to be value stocks and have risen over 10,000 percent each in 10 years.
Value investing has proven to be a good strategy to create wealth. As Benjamin Graham says, "it is much better to buy a wonderful company at a fair price than a fair company at a wonderful price.”