The origins of value investingValue investing, along with the work of Graham and Dodd, is usually central to the work of fundamental analysis. Graham and Dodd explained a stock is really a claim on the cash a company is expected to generate in the future, or its intrinsic value. Just know the following:
- If a stock is trading for less than the cash it will generate, it’s undervalued and may be bought.
- If a stock is trading for more than the value of cash a company is expected to churn out, it’s overvalued.
Using fundamentals to see when a stock is priced rightGraham and Dodd took things a bit further than just weighing whether stocks were over- or undervalued. Other lessons from Graham and Dodd worth noting include
- Protecting yourself: Buy stocks well below what they are worth, or their intrinsic value. This extra cushion gives you a margin of safety in case the business runs into trouble and the stock price falls further.
- Investing isn’t necessarily speculating: While it’s tempting to think of Wall Street as a giant casino, Graham and Dodd explained that wasn’t necessarily the case. If you’re buying stocks with little information about the companies’ business, then yes, you’re betting or speculating. When you speculate, you bet you can sell the stock to someone else for more. But with fundamental analysis, you become more of an investor by understanding what you paid and what you can expect to receive in exchange.
- Being cautious of companies with excessive debt: Companies that borrow heavily to finance their operations may face onerous debt payments during difficult economies.