Finance geniuses like Ben Graham, Warren Buffett, and Charlie Munger have one thing in common.
They are all value investors.
These are people who consistently have beaten the market via longterm investment strategies.
That and figuring out the intrinsic value of a stock.
What is intrinsic value?
The rational for intrinsic value is easy to understand but hard to implement.
For example, there are stocks in which the market value may not reflect its real value.
Investing in stock X of low market value but high intrinsic value will be rewarded.
Since the market will always correct itself.
Thus, holding on to undervalued stock X once the price skyrockets is basically value investing.
Why stocks are undervalued by the market?
Value investors like Buffett don’t believe that the market is efficient.
There are a ton of factor why the market can mistakenly undervalue a stock.
There are market crashes, herd mentality, and a few other psychological reasons which we are not going to discuss here.
In short, the market is not perfect, but it has been known to correct itself.
So again, undervalued stock x, once the market corrects itself will now sell for its intrinsic value.
How to determine intrinsic value
Determine the real value first
This is something which a lot of new investors wants to know more about.
The answer is that you should do fundamental analysis.
It is not enough to read a company’s annual report.
You should put every stock you want to buy under scientific scrutiny.
There are stock analysis software out there today that uses all the important valuation ratios.
This is the way to go.
Rumors, tips, and following the crowd is not something you can back scientifically.
How to learn more about value investing
There are a lot of resources online that you can read up on.
It’s also fun to learn more about personalities in value investing.
Reading up on Ben Graham or Warren Buffett is quite interesting.
But if you really want to learn you can purchase books about the topic.
You can buy books authored by trusted individuals like Seth Klarman, Joel Greenblatt, Peter Lynch, Howard marks, and a whole lot more.
As you can see value investing is not just a fad.
There are a lot of successful investors still using this investment strategy.
Choose for yourself
There are a few investment strategies you can use if you want to invest.
Value investing is just one of the many.
However, it is up to you to choose which strategy you are most comfortable in.
There is no fast and hard rule.
All of these strategies can make or break your investment career. The best approach is to find what fits your personality and stick with it.
I guess the best advice I heard all of my adult life is to focus and be consistent.
Focus and consistency will help a lot when you are aiming for the longterm.
The sweetest reward is seeing your money grow by leaps and bounds every year.
What is Growth investing
Growth investing is a strategy that investors target companies exhibiting signs of above average growth. Companies that show a sign of potential in growth.
It is investing with the aim of having an increase in the wealth via a short term or long term capital appreciation. The investors who practice growth investment strategy are known as growth investors.
They refer to growth investing as capital growth strategy. This is because the aim is to increase their capital gains significantly.
These stocks usually have higher volatility, less downside protection and low dividend yields. There are various concepts of growth investing.
It is good to consider the rate of growth, type and amount of risk and other key elements.
NAIC – the home of growth investing
There is a very popular organization that uses and teaches about growth investing strategy. It is known as National Association of Investors Corporation with the initials (NAIC).
Some of the questions that one should ask themselves before growth investing include; what is the intrinsic value of the company? does the company have a historical earnings growth that is strong? Are the forward earnings growth strong? Is the company managing its costs and revenues efficiently? Is there a possibility of the stock doubling in a span of five years?
The stock data investors analyze before making a decision to invest include Return on Equity, raising Earnings per Share, Projected Earnings, emerging markets, Blue chips, Second-hand life policies, Recovery shares, internet and technology stock.
Return on Equity is a mathematical expression that shows how profit can be obtained. It is a percentage of the ratio of a company’s net income to total shareholders’ equity.
If a company’s Earnings per share are on a constant raise, more growth investors will be attracted to invest in them. It is not just an increasing earnings per share but the cash flow has to be genuine and from legit business transactions.
Companies with innovative minds in the web and new technologies attract many growth investors. Though Blue chips are companies which are usually preferred, small-cap companies pose a higher potential to growth of prices.
Fast and steady growth rate
Putting a security at a high price, with the aim of having a high growth is a risky move.
This is because in case the growth does not pull through, the security price will fall at a very high speed. A quick growth is not always a good thing as a company or business might find themselves in trouble.
Value investors tend to look at investing in stocks that are currently trading at a cheaper price than their worth. Growth investors look at the future.
Growth investors invest in companies that trade at a higher price than their actual intrinsic value. The similarity of these two types of investors have a common goal of raising their wealth.
People have different views when money is involved. The main aim is making that money grow.
That is the most important investment objective. Accomplishing this objective varies with the investor’s time horizon and their tolerance to risk.
What is growth investing? As discussed, growth investors concentrate on growth.
Stocks might be currently expensive but growth investing believes that with expansion of the business, the investment will be worth it in the long run.
Value investing is the philosophy of investing in a particular security when its share price undervalues its intrinsic value or true worth.
Introduced in 1934 by Benjamin Graham through the book Security Analysis, this is an investment method where you can buy stocks that are considered to be out of favor in the market mostly due to irrationality in part of the investors.
In extreme cases, this reasoning can and usually pushes the price of a stock below its actual value.
Therefore, when you come in as a value investor you will mainly determine the true value of a stock and consequently take advantage of this investor irrationality.
A successful investment strategy
Value investing can be a very successful investment strategy.
This investing philosophy is at best demonstrated by the successful ventures that popular investors such as Charlie Munger, Warren Buffett and John Templeman have had. These are just some of the investors who have followed Graham’s investment principles and reaped a great deal of benefits from them.
The main thing here is to gain from a stock that other investors in the market would consider valueless.
Through value investing you are not a mere participant in the market but you are investing in a security that will eventually yield to better returns.
Value investing key concepts
As a value investor there are key concepts that properly outline the entire value investing philosophy adopted by Benjamin Graham. Of all the principles that Graham pointed out, two stand out.
The first concept is how you analyze a company with the mindset of a business owner and secondly how you count on the market irrationality in the short term.
Apart from these two concepts, you will also have to consider the margin of safety and determine the intrinsic value of any security as well as.
Generally, as a value investor you will have to do the following;
First you have to approach the stock evaluation process from the perspective of a business owner.
Here you will have to act like you own the business which you will eventually do when you buy the stock from the issuing company.
Then you also have to establish if the price of the stock has been undervalued and that it doesn’t relate to the stock’s net asset value or its true worth. The two should be different before you invest in such a security.
The next thing you have to embark on after identifying an undervalued stock is to determine its intrinsic value. These values usually vary.
Most importantly bear in mind that this is usually an estimate because you can’t in the actual sense calculate the intrinsic value.
Lastly, you have to establish the margin of safety as a value investor. In doing this, you have to ask yourself whether the stock in question is sufficiently undervalued to withstand uncertainties in the market.
This will enable you to know if such a security is a worthier investment that will yield good returns later.
Succeeding through value investing
Therefore, you can only succeed through value investing if you take into account these principles and apply them as explained by Benjamin Graham.
They are the key to making the most of out of any security or stock that you want to put your money in.
Naturally, not all trades will bring you profits but still by knowing is expected from you as a value investor, you will hardly make costly mistakes.
Accounting knowledge and concepts are very instrumental in the success of any value investment.
The knowledge learned in classroom or lectures is important, although you also need to have the practical experience in order to allow for the accounting knowledge to settle and retain in a way it can be used efficiently in the real world to produce great value for an investment.
How does one learn accounting for investing?
Before making any investment, it is important to have adequate background information about the potential investment. To interpret this information, you need to have basic understanding of accounting and the financial statements.
Accounting books are a first step into unpacking the secrets of successful investment. Start with sorting a list of books about investment, stock markets and interpretation of financial statements.
There are no shortcuts thus, you have to take a firm decision, have patience and passion. This is because learning to interpret financial statements can be very frustrating especially to first timers.
At this stage, it is advisable to learn common accounting concepts and principles as this shapes the business language.
Accounting books provide real case scenarios and their interpretations of financial statements which helps you to relate with the situation at hand.
Once you get the hang of running through the numbers, then you can consider upgrading your knowledge to a financial statement analysis software like at old school value.
After learning the basic concepts
After learning the basic concepts, an investor needs to specialize deeper into financial accounting. Financial accounting is very fruitful when you have an understanding of interpreting financial statements.
This allows you to spot discrepancies in the balance sheets and income statements which can adversely affect the value of the investment. With such knowledge, you can understand better the financial markets; keep financial records which are exact and error-free and also up-to-date.
Before taking the step of investing money in the markets, it is important for a first-timer investor to seek the counsel of a financial advisor in order to get the real situation on the field.
Practice financial investment
One can practice financial investment through an investment simulator which is a learning resource in financial accounting which helps amateur investors to investigate the behavior of money markets. They are online programs that trade in different markets which are not real.
The learner opens an account and invests in make-believe markets. The markets mimic the movement of actual investment markets, and as such, they provide a platform for practice and learning the risks and tricks of financial investments without having to risk money while learning.
This program can be very useful and insightful when one has the understating of the basic financial accounting concepts and principles.
Learning accounting for investing requires passion, dedication and a determined person since it is not an easy theory subject.
Financial investment requires interpretation of concepts and principles of accounting, financial advice and practice.
It is also great to study the markets and observe their behavior before investing actual money.
As such, a person with no accounting background can use these simple guidelines to learn accounting if they are determined to invest in the financial markets.
Making any investment means accepting risk with the possibility of making a return, stocks are no different. Before investing in stocks, an investor must define how much they are willing to lose.
Investments are done with goals in mind and risk tolerance also means the risk that you will be unable to achieve your goals. Knowing your risk tolerance will help an individual to develop an investment strategy.
Some people buy stocks that they can hold for a longer period of time so that they can make the most return from the price movements while others prefer to hold stocks for a shorter period of time so that they can get in and out of the market within a shorter period of time.
The factors that determine your risk tolerance are:
Will you need the money in 10 years, 20 years, 5 years, a year or three to six months? This will determine the risk that you can take, it t will determine if you will buy a stock that you can sell in the short term or take a longer period of time.
Age can also determine the time frame, a person who is younger can hold their stocks for a longer period of time as opposed to a person that is a bit older and may want to make use of the money that they have invested within a shorter period of time.
The younger person can then let his money grow for a longer period of time so that he can use it for long term goals.
What do you plan to do with the money that you generate from the stocks that you have invested in? This question will also help an investor define their risk tolerance.
Is the investor putting money away so that he can have college money for his children in a few years? This will mean that the money will be put in safer stocks because the investor cannot afford to lose money that has been put away for education or a house or other basic needs.
Your investment goals will determine if you will invest conservatively or you will take a higher risk with your stocks.
Risk Capital/Net Worth
This is the amount of money that you can afford to lose.
An individual with a higher net worth can afford to trade more volatile stocks as opposed to trading more conservatively because even if they lost the money it would not affect their lifestyle.
If an individual has more experience in trading stocks then they will feel more confident in investing in more volatile stocks for a higher return.
Whether you are a long term investor or a short term one, no one likes to lose money and just because your stocks have gone down you do not have to sell them, the market sometimes goes down then comes back up.
Every individual should have a diverse portfolio that includes short term medium term and long term stocks, investors should also try and invest in many sectors of the economy as possible so that they can diversify their risks.
Defining your risk tolerance will enable you to determine the volatility of stocks and see if they fit in with your investment strategy and if they will help you to achieve your investment goals.
Stock valuation of a stock is usually an indicator of how profitable a particular security is. This is an important evaluation that usually investors and even portfolio managers depend on while investing in this type of security.
As an investor you cannot just invest in a security blindly. You first have to know its internal value including its current market price.
This way you will know whether the stock is undervalued or overvalued and whether you will profit by putting your money on it. This underlines the importance of valuing stocks.
For instance, if you were to assume that a particular stock will reach a fair value by either increasing or decreasing in the market, knowing the value of that stock will help you determine if it will yield attractive returns.
Being an investor, you certainly want your money’s worth, a reason why you need to value a stock and see whether you have invested your money wisely. Correct evaluation of a stock will however depend on the reasons why you want to invest in this kind of security.
If you expect a quick or a large return from your investment, then you need to establish if the risks involved are worth taking. Even if you are interested in paid dividends, you have to know what your immediate needs are and whether you are prioritizing them by investing in a specific security.
This assessment will help you in valuing a stock and know whether it is worthy of all your efforts.
Valuing a stock
Just like valuing a private business before buying it, valuing a stock is a great way of knowing if what you are investing in will yield better returns in future. When buying a private venture, what you will mostly look at is how viable the entity is and whether it will generate a steady flow of cash in terms of profits.
With a stock, you are not investing in the cash the company will generate in future but you are putting your money on the company’s net worth and the right to the profit it will make as well. The revenues and earnings that the company makes is something that should not concern you as an investor.
You can use a stock analyzer to make things easier.
This is because you cannot spend the revenue to expand the business but you can only spend the cash that remains after all expenses have been paid.
The importance of valuing stock
Generally, the importance of valuing stocks is that you will invest in a security with confidence if you know its net worth (shareholder’s equity). This way you can estimate a stock’s real value, its future growth and the cash it will generate.
By knowing the value of the stock you can then be assured that you are investing on a security that will earn you attractive returns. Most importantly, remember to buy the stock at a discounted price ( a margin of safety) such that if the security earns less than you expected you will still earn good returns on your investment.
Accounting information and financial statement analysis has a great significance in the current business world. It gives important insight into a corporation’s current financial stance.
It is a vital element since it provides essential financial position in the past, current and the future. It depicts how the company will perform in the near future.
It provides information that is useful to various stakeholders and other users that are significant to the company. These stakeholders include, investors, lenders, creditors, customers and debtors, employees and the government.
Corporations, government and non-profit organizations finds it mandatory to prepare their periodical financial statement. They should comply with the generally accepted accounting principles, GAAP.
This principles that will represent a complex set of accounting methods, assumptions and also definitions. This is essential in providing a proper and standard criteria of giving financial statements of a given business.
This complex financial information is well gathered and reported by qualified accountants and bookkeepers. They will track down daily financial transactions.
They play an important role in helping organizations and business plan and consequentially control their own finances.
The various business accounting users who find accounting to be a play a vital role in investments are summarized below.
Financial statement are crucial to investors in relation to risks and returns involved in their investments. This information will enable them decide whether they should continue to invest in the company. They will be in a position to assess whether the business will have the ability to pay annual dividends.it is also important for the investors to measure the management of the business.
The short term liquidity of a business is essential to creditors and supplier. This will enable the creditors and supplier to assess the ability of a business to pay short term debts in time.
Debtors and customers
The survival of a business is important to debtors. This will enable them to analyze the prosperity of a business. Customers have a long term interest to the company’s product or services.
The customer may create loyalty to the business product and also rely on them.
The business will rely on their lenders for finance. Banks and financial institution lends money to the business. This will require relevant financial information to the banks concerning the business in order for them to determine whether they will give out loans.
The profitability continuing of a business is crucial to employees and trade organizations that represent them. They are interested in accounting information in order to determine the employee’s prospect in the business.
It is also important to know their pension funding plans and the retirement benefits.
The department of corporate tax heavily relies on accounting data in order to calculate taxes.it will also review the financial statements to authenticate whether the company is compliant with the tax guidelines that are put in place.
The state and federal levels are more aggressive in their legal role to review the accuracy of financial information. They ensure that the accounting procedures are followed strictly and accurately in line with the laid down accounting guidelines.
There are many reasons why it is important to hire a professional who is well versed with accounting principles. If one is seeking to significantly grow his/her capital. This will attract investors and also be on the safe side with the tax authorities.
Compound Interest has been called the eighth wonder of the World, Albert Einstein called it “the greatest mathematical discovery of all times”.
What is compound interest?
Compound Interest is interest that is added to the principal on a deposit or a loan so that the added interest will also earn interest. Compound interest is something that is earned on interest.
A good example is when you deposit your money in the bank; imagine that you had deposited $100 in your account and your bank compounds interest annually, if the bank’s interest rate is 10% annually, it would mean that the account would grow by $10, this interest is added to your account to make it $110.
At the end of the second year your interest would be $11 taking your account to $121, and the third year the interest would be $12.1 making your account $133.1 and so on.
Compound interest vs simple interest
Comparing compound interest to simple interest will give an even greater visual of the magic of compounding your money. Simple interest is interest that is calculated on the principal only.
Imagine that your friend also deposited $100 at the same time as you but his banks uses simple interest instead of compound interest like your bank. The interest remains at 10% every year; at the end of the first year his account will grow by $10 making it $110, at the end of the second year, the bank will calculate your friends interest on the initial profit $100 and he will make $10 making his account 120, the third year the interest will again be calculated using the principal and his account will grow by $10 making it $130.
When the two accounts are compared at the end of the three years, the account that uses compound interest has a balance of $133.1 while the one that uses simple interest has $130. If a larger amount had been deposited at the bank for a longer period of time, the results would be mind blowing.
Compounding works best for huge amounts of money that are invested over a long period of time, it is also better if the periods of calculating the interest are shorter like monthly instead of yearly.
The math of compounding interest
The formula for compounding compound interest is; FV=PV(1+i)^N. FV is future value, the amount that you will have when you want to have your money back. PV is the present value, the principal that you have today, what you will be investing or depositing.
i is the interest that your money will earn and N is the number of years that you will invest your money for. Example if $1,000 is invested at an interest rate of 10% annually for 10 years, the of your money at 10 years will be calculated as follows. PV=$1,000, i=10% and N=10 years. FV= 1000(1+10%)^N, the interest would be $1,593.74 and the amount after 10 years(FV) would be $2,593.74.
The calculations should not scare you, there is a free online compound interest calculator.
Every Individual, the young and old alike should look into ways in which they can save and invest so that they can secure their future. You should take advantage of compounding to save for retirement and make long term investments.
To make the most of your investments, you should also look into using a fundamental stock analyzer to help you with your calculations and stock analysis.
It can only help you compound your money so that it works for you and not the other way around.
Compound interest can turn your investments into millions. Of course you should avoid compound interest on your loans and credit cards or you will end up paying huge bills.