Value investors are bargain hunters and many investors describe themselves as such. But who is a value investor? In this paper, we begin by addressing this question,and argue that value investors come in many forms. Some value investors use specific criteria to screen for what they categorize as undervalued stocks and invest in these stocks for the long term. Other value investors believe that bargains are best found in the aftermath of a sell-off, and that the best time to buy a stock is when it is down. Still others adopt a more activist approach, where they buy large stakes in companies that they believe are under valued and mismanaged and push for changes that they believe will unleash this value.Value investing is backed by academic research and also by anecdotal evidence –the success of value investors like Ben Graham and Warren Buffett are part of investment mythology – but it is not for all investors. We will consider what investors need to bring to the table to succeed at value investing.
Who is a value investor?
In 2011, Morning star, a widely used source of mutual fund information,categorized 2152 equity mutual funds, out of 8277 domestic equity funds, as value funds.But how did it make this categorization? It was based on a simple measure: any fund that invested in stocks with low price to book value ratios or low price earnings ratios and high dividend yields, relative to the market, was categorized as a value fund. This is a fairly conventional approach, but we believe that it is too narrow a definition of value investing and misses the essence of value investing.Another widely used definition of value investors suggests that they are investors interested in buying stocks for less that what they are worth. But that is too broad a definition since you could potentially categorize most active investors as value investors on this basis. After all, growth investors also want to buy stocks for less than what they are worth, as well. So what is the essence of value investing? To understand value investing, we have to begin with the proposition that the value of a firm is derived from two sources – investments that the firm has already made (assets in place) and expected future investments (growth opportunities).