At its most basic, value investing involves buying undervalued stocks cheaply, and waiting until they rise substantially before selling out. Like any successful investing system, it gives the lie to the Random Walk theory, which suggests that if you select stocks at random, they will perform at least as well on average as those picked on value criteria.
As an investor in value stocks, you should also have an eye on growth and a good dose of common sense. You should first have a pension, life assurance, and rainy-day money – perhaps £5,000 stashed in the highest-interest account that you can find. You should own your own home. The stock market is not for playing with the cash that you need.
It needs courage to buy a share when it has fallen sharply in price and nobody else is buying, but this is often when you can pick up a bargain. As a value investor, you must take the long view. In assessing a company, you cannot shirk the numbers. Days 6 and 7 will give you an understanding of the basics of accounting and ratio analysis.
Consider qualitative factors. The gap between price and true value is likely to be closed faster if the underlying company has a strong franchise, and is a market leader or close to it, with growth prospects. It helps if the management is capable, and it should be, above all, honest. The broader market should not concern you because, over the medium to long term, good and bad news tend to balance out.
City professionals are more successful at stock picking than most. They are exposed to markets all day long and are savvy about investment strategy. They know to buy when the markets have hit rock-bottom and to sell before a bull market has risen too high. They select their own stocks and so are comfortable using online brokers, which normally are cheap but do not offer advice.
To decide when to sell, like most investing decisions, is an art and not a science. In April through to three weeks into June 2006, the FTSE-100 lost about 8 per cent of its value but a significant number of investors had sold out in advance. Private investors sold £3.1 billion of shares in February and March 2006 compared with only £959 million in April and May, according to research by Capita Registrars.
Market feedback suggested it was investor attitude and not market funda¬mentals that had driven the retreat. The bull market had seemed tired for months earlier and, with a high oil price and talk of raising interest rates, it was looking increasingly unsustainable. It had lasted more than three years, which is long by historical standards, and assets had become expensive.
Commodities and some emerging markets stocks fell up to 40 per cent in value in May and June 2006, and there was a feeling they had further to go. Some of the newly established funds were waiting for a temporary market rise which would give them a chance to sell out more profitably.
Anyone who wanted to stay invested in a slumping market could buy defensive stocks such as pharmaceuticals and, in mid-2006, media, because it was out of favour. The market recovered and, on 20 October, the FTSE-100 index reached a new five-year trading high, within a whisker of breaching the 6,200 level. Many stocks were overvalued on fundamentals and buying was sustained often on bid speculation, sometimes with a limited basis in reality. The market was showing further symptoms of a tired bull market.
