There are mounds of available information about Value Investing and value Investors.

In this article, we cover the fundamental steps you would need to take in identifying Value Companies.

What is Value investing?

Value investing is the practice of seeking assets that are undervalued compared to their market price. In other words, the undervalued asset is worth more than what the market prices it to be worth.
If the stock’s intrinsic value is worth more than the current market price, that is exactly where the value is earned. Value investing is a long-term investment strategy and is heavily dependent on the fundamentals of a company, such as its Cash flows, earnings, book value, and dividends. Falling stock prices are welcome, due to them being available at discounted prices.

The Father of Value Investing
The concept of Value investing originated in the mind of Benjamin Graham and was popularized by Oracle of Omaha, Warren Buffett. These value investing masterminds believe in being picky stock pickers and holding them for the long term, even if short-term market news or developments cause the stock price to fall.
Why you should start Value Investing.
Value investing has many benefits to it. Equities are the best long-term performers within the universe of asset classes and have a high potential for superior returns to be earned when the market does recognize its true value.

What should always be compared to higher returns, is the level of risk undertaken to earn such returns. With value investing, the risks are often lower than short-term investing, because it entails long-term investment and focus.

Value investing can be used as an investment strategy across stocks, bonds, real estate, and other asset classes.

Seek out undervalued companies.
A company is undervalued when its discounted cash flows per outstanding share are worth more than the market price.
One should establish from this whether cash flows are growing or not. Free Cash flow can tell an investor how much cash is left over, either to reinvest back into the business, or pay back shareholders through dividend payments.

Reliable metrics for identifying undervalued stocks are the Price to Earnings ratio, EBIT to Enterprise Value ratio, FCF yield, and dividend yields.
These metrics should not be used in isolation and an depth assessment of the quality of earnings is needed to establish whether the company is undervalued.
Analyze financial statements.
The income, financial position, and cash flow statements are the most important pieces of information that are publicly available to all investors.

Understanding these crucial documents is crucial for success.

The statements indicate a company’s revenue, capital structure, and amounts of cash flow generated from operating, financing, and investing activities.

It’s important to analyze EPS in light of revenue growth as well as Free Cash flow growth. A simple way to do this is to use financial ratios that can magnify the state of a company’s profitability, liquidity, solvency, and overall financial health. Gross profit and operating profit margins are good metrics to keep an eye on too.

On the Income statement, one can assess whether shares have been diluted, which hinders value directed toward the shareholder.

The Balance Sheet can be used to see how the company finances the purchases of its assets, which would be either through debt or equity. The Debt/Equity ratio is then a good measure of solvency. High debt-to-equity ratios are not sustainable, and this should be confirmed by the current ratio, which measures current assets to current liabilities.
The Cash flow statement essentially communicates how much cash is generated through the operating, financing, and investing activities of the business. It assesses how cash was used for the period, in all the businesses core activities.
Economic moats.
A company with a significant economic moat is said to have a high competitive advantage.

This can be measured using the Return on Capital employed and the Return on invested capital financial metrics.

Warren Buffett suggests one think of a business as a castle and an economic moat as a body of water surrounding the castle. This moat is full of sharks or crocodiles, which deters any threats (competitors) from ambushing the castle.

Brand strength, Goodwill, and intellectual property are other ways to evaluate competitive advantage.

Goodwill can be defined as the intangible value of the company’s reputation, overall customer loyalty, and its non-physical assets. Intellectual property to the legal rights that protect the company’s ownership of its creations, such as patents, trademarks, and copyrights.

Evaluate management competence and quality.
Management’s efficiency is the foundation of the company’s success and growth.

This is a major aspect, which some investors ignore. The management team has responsibilities to create value for shareholders, either through intentional capital appreciation, dividend payouts, or share repurchases.
The decisions taken to achieve this growth are largely dependent on the capital allocation decisions of management and organizational structure. A good metric for management efficiency is the return on assets, return on equity, as well as return on capital employed.

Another indicator of guaranteed management performance is the level of insider ownership. Management then has an incentive to act in the interests of shareholders as they are shareholders too.

The CEO’s leadership style is also another determinant of future growth and success. Management success is also dependent on its ability to manage risks and implement risk management practices to cushion against firm-based and economy-based shocks.
Monitor your investments.
Just because your investment has a long-term investment horizon does not mean you should ignore current happenings in the financial world.

It is important to keep abreast of company news and developments. One’s knowledge of the firm’s financial position and health needs to be up to date.

Short-term fluctuations are usually just noise. However, one should never fall into the trap of being unaware of investment happenings.
Diarise earnings calls, and read annual reports and quarterly filings, as this will help to forecast the direction in which the Company is heading.

It is also important to read between the lines and question everything.

Rebalance your portfolio as needed, to maintain diversification levels. Also, keep a close watch on the secondary events that could impact the demand and supply of the underlying assets you are investing in.
Key Takeaways
Here is the summary of the above discussion:
Identify undervalued companies, as these companies with strong fundamentals usually outperform in the long run.
Through thorough analyses of the income, balance sheet, and cash flow statements, one can evaluate the financial health and position of the company.
Assess whether the company has an economic moat. This can be achieved through identifying its ROIC relative to industry peers, as well as return on capital employed.
Evaluate management efficiency through the assessment of the quality of capital allocation decisions made in the period. Metrics such as ROA and ROE can aid in this process.
Monitor your investments, by making note of your portfolio’s performance and constantly evaluating the company’s financial position.

There are many long-term positives associated with value investing. However, being a long-term investor, means one needs to be patient and as rational as possible.

Every fluctuation in stock price does not require a reaction. Interrupting the magic of compound interest can impact your earnings, so long-term success does require high discipline levels.

It may seem difficult at first, but the benefits of value investing are robust and thriving if only you wait.

Book a call with our expert Investment and Wealth Advisors and we will guide you on your Investment success journey.