There are many investment strategies used by a myriad of both individual and professional investors. Some prefer the growth strategy while others prefer a value approach. While both good in their own regard, a combination of the two trumps them both, and here’s why.

Value Investing

The fundamental goal of value investing is, quite simply, to buy a stock when it is low and sell when it is high. Seems easy, right? Though it may seem like common sense, the vast majority of investors do not do this. Very few use this strategy effectively. Some of the greatest investors of all time, such as Warren Buffett and Benjamin Graham, used a value approach in their investing careers.

The primary characteristic of a value investor is that they love finding good deals. It might be best to think of them as shoppers who scour through the Sunday newspaper for coupons. This is exactly what they do, but instead of looking through the paper for good deals, they look through the universe of stocks. At any point in time, there are dozens of companies whose stock is depressed. There are many reasons for this to happen, such as disappointing quarterly results, unexpected charges, changes in leadership, boring products, etc. A value investor will weigh the drops in stock value with the news that caused it. If it appears to the investor that the market overreacted (as it almost always does), then he or she might pick up some of the shares at a discount and wait it out.

In addition, a value investor does not look for companies who have yet to prove their products. A great example of this is the biotechnology industry. Many of the smaller biotechnology firms don’t even make money at this stage, as they are still undergoing heavy research and development and clinical trials. A true value investor would never invest in a company that does not make money.

Value investors want to see that the company is making money and that the stock is cheap relative to the value of the company. There are many ways of determining this, but perhaps the most widely used method is to look at the price-to-earnings ratio (P/E) of the company. This ratio allows the investor to quickly determine the value of the stock relative to the amount of earnings generated by the company. The lower the ratio, the better the bargain the investor is getting. This isn’t true in all situations, of course, and must not be used as the sole measure for evaluating a stock. The point is that value investors seek quantifiable facts to determine whether a stock is undervalued or not. This, as value investors call it, is a “safety net.” If the company is undervalued to begin with, bad news or a market downturn will not affect the stock as much as a stock which is overvalued.

By using such quantifiable measurements, the value investor can safely stay away from using his or her emotions in stock selection.