Most investors assume that one can make money in market either by following recommendation shown on news channel or by looking at charts or one has to be just lucky. But this is incomplete assessment of what it takes to make money. One need not be genius or lucky to invest and earn, but knowledge and common sense is required.
Making knowledgeable investment decision can have a significant impact in your life. It can provide for a comfortable retirement, send your children to college and financial freedom. Combination of knowledge and common sense is called value investment.
Value investment is not a rocket science, it’s merely requires understanding of few sound principals. One of the principal is to check the worth or intrinsic value of the stock before investing. Intrinsic value of stock is the actual value of stock determined by the fundamentals of company irrespective of the market value. It is an important aspect because it determines whether the stock is undervalued or overvalued and let the investor take advantage of temporary mispricing of stocks.
It is always advantageous to invest in undervalued stock, because if stock price of undervalued company falls , it is still worth as someday the price is likely to recover but if stock price of overvalued company crashes it is unlikely to regains its former inflated value and history has proved it. This is what happened in 2000 technology bubble bust.
No stock sell for its intrinsic value and this create investment opportunity.
Another principal of value investing is margin of safety. It means buying stock in less than its intrinsic value or in simpler terms buying stock at discount. Margin of safety gives edge over just blindly buying a stock along with assurance that the company can survive during poor economic times.
If the stocks are dear and valuation are exceeding intrinsic value and there is no margin of safety you sell. Forget the noise that swirling around you, use your own knowledge and sense to pick up the stock.
I have down pat this one quote of Warren Buffett –“Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years” and done an analysis on bases of these, in which if we consider Sensex data from April 1, 2002 to 15 Sept, 2016, it can be seen that the probability to get positive Sensex return for tenor of one year is 78% and negative return is 22% but as we increase the term to 3 years, Sensex return is positive 95% times and negative 5% and with tenure of 10 years Sensex has given almost 100% positive returns. This implies that longer one invest in equity probability of negative return decreases.
Simple logic for investment is to see intrinsic value and margin of safety of stock and invest for long term and your investment will be sort.