Investing is an act of committing certain funds today in the wish of earning a positive rate of return in the future. Investment are made for two basic purpose i.e. Value appreciation and Current income. An investor can be benefited by the appreciation of the value of the asset or financial instrument and on the other hand he can also be benefited by the periodic cash inflows generated by it. In this article let's be specific about common stock investing.
A common stock is a security that gives the holder ownership right over the form up to the portion of his/her investment. Stock can provide return in forms of Dividend and Capital gain. In 1602, Dutch East India Company established the first ever common stock which was introduced on the Amsterdam Stock Exchange. A stock exchange is a market where securities including common stocks are traded. Nepal Stock Exchange (NEPSE) is the only stock exchange facilitates stock transaction of the Nepalese publicly listed companies with the help of 50 registered brokers as of April 2019. The stocks of Biratnagar Jute Mills Ltd. and Nepal Bank limited were floated for the first time in 1937.
Stock investing is sometimes misunderstood as stock trading but trading is short term oriented and is speculative in nature. On the other hand, Value Investing is about buying cheap and undervalued stock and holding them for a longer period of time to rip benefits from it. Value investing according to Graham and Dodd is the practice of purchasing securities or assets for less than they are worth. It is an investment philosophy of conducting in-depth fundamental analysis and pursuing long term investment results and resisting crowd psychology that most investors follow. While talking about undervaluation of a stock an investor must be skeptical and judgmental because that business may have a broken business model, hidden liabilities and corrupt or incompetent management.
Value investing involves two core concepts: intrinsic value, and margin of safety. The intrinsic value is what you – the value investor – believe an asset is truly worth. The margin of safety is the gap between its intrinsic value and the price at which you would feel comfortable buying it (in order to give you sufficient upside, and also to limit the downside if you are wrong). Graham points out that a business should be worth to any private owner at least the amount of the working capital, since the business ordinarily would be expected to fetch that much at liquidation. Furthermore, Graham wasn’t satisfied with merely buying firms trading at less than net current asset value. He required an even greater margin of safety and only looked at stocks whose prices were less than two-thirds of net current asset value. Simply saying, he would buy stocks of a company whose intrinsic value is Rs.3 while it is trading currently at Rs.2 per share.
Value Investors do not time the market but they usually buy stocks at a bargain price. According to value investors, Good companies are those companies which have strong barriers to entry, reliable customers, low risk of technological obsolescence, limited capital requirements, abundant growth opportunities and thus significant and growing free cash flow. Value investors should exit the market when a security reaches full value.
To learn more about Value Investing, I recommend you to go through the book “Security Analysis” by Benjamin Graham and David Dood.