Value Investing is an investment approach where you purchase something at a price less than its intrinsic value.
Let’s break this down further.
1. Price is an amount of money paid for something, like an asset
2. Value is what you get in return for paying the price
3. Intrinsic refers to the features of the asset that generate the value
When you choose value investing as an approach, your money is predominantly invested in value stocks. And value stocks are stocks that are currently trading at a price lower than their actual intrinsic price.
Now, you might ask…
Why are stocks undervalued?
There could be a number reasons for a stock to be undervalued, including the company having an unusually bad year, bad publicity, regulatory changes, and so on. Therefore, while historically the company might have a good track record, certain incidents or circumstances could have caused the value of its stock to drop for a certain period of time.
Why invest in value stocks?
Let us try and understand the logic behind buying a value stock with a real-life example. Imagine that you have your eye on a branded shoe but they it’s expensive for you to buy. As luck would have it, the brand outlet that is closest to you has to vacate its premises in a hurry due to some problem and therefore have a clearance sale with highly discounted prices. The shoes you want are now 40% off so you go ahead and buy them. You buy the shoes at a lower price because you know that the discounted price does not diminish the value or quality of those shoes, the price was lowered due to a larger circumstance and not because the shoes themselves had a problem.
Similarly, the quality of a stock that has been undervalued does not necessarily diminish. While the stock might be selling at a lower price right now, it is only temporary owing to certain extenuating circumstances. Therefore, the logic behind investing in value stocks, is to buy while the price is down, with the knowledge that these stocks have the potential to grow.
A scheme that follows value investing approach aims to provide potential returns for investors by following this very logic. However, investors need to keep in mind that these schemes tend to be very risky and should be approached with the right risk appetite. These schemes are also better suited for long term investing to reap potential benefits.
Remember that finding value stocks, that will help you earn potential returns is often a matter of luck. The market is always unpredictable and therefore, as an investor you should be capable of accepting some amount of risks when it comes to value investing.
An investor education initiative by ICICI Prudential Mutual Fund
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