Strategies Used By The Value Investor

Value investor Warren Buffett, uses specific strategies to make sizable returns in individual stocks. There are three major steps that Value Investors take and they are: 1. identify great businesses, 2. buy them only at a huge discount and 3. wait for the market to realize their true value or overvalue them.

Step 1: Identify Great Businesses

Always remember that when you are buying a stock, you are not buying a lottery ticket. You are buying part-ownership of a company. If you want the value of your stock to increase over time, you must identify and invest in great businesses. And you must truly understand the business behind the stock. So, what is a great business? It is one where we can predict with confidence that, over the long-term, the company's earnings (profits) and hence stock value will increase (if a company can make increasingly higher profits in the future, it would become more valuable). When the value of the company increases, the stock price will eventually increase.

While bad news and disasters like wars, recessions and new competition will always cause the market to panic and stock prices to plunge, a very good business is one that we are confident will always recover and prosper after such events. In the next part of this chapter, you will learn specifically how to select companies that are financially strong and have a high certainty for growth. In this case, you do not have to depend on market predictions for your stock's price to rise, but you are certain it will rise because of its strong business fundamentals and earnings.

Step 2: Buy them Only At A Huge Discount

Great companies with strong earnings, financial strength and high growth potential are usually expensive to buy (their stock price is often overvalued) as they are usually the favourite of fund managers and stock analysts. However, the market always goes through booms and busts and there will always be short-term bad news that hits a company, no matter how great it is (e.g. the company reports lower than expected profits, new product failure, recession fears). It is under these circumstances that the irrational short-term orientated market will panic and sell the stock until its price is way below its intrinsic value. The smart value investor who knows the true value of the stock, will buy as much as he can at such times, thereby getting a huge discount. He knows that the market will eventually come to its senses and recover, correcting the stock price and bringing it up to its true value. This is when very substantial returns are made for the
investor who is patient and confident in his purchase.

Step 3: Wait For The Market to Realize a Stock's True Value Or Overvalue It.

The best time to sell is when the stock market is booming or there is good news that makes the market over-react. Investors will flock to buy up so much stock that the prices of all stocks rise above their intrinsic value. When a stock is highly overvalued, it is a good time to sell as you will make a huge profit.

Now you can apply the 3 strategies used by Value Investor Warren Buffet.