Video Manual - Value Investing: when price is too low, it is time to buy; and when it is too high, it is time to sell
19 February 2015, 15:11
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Value Investing operates from the principle that the prices of financial assets are mean reverting. In other words, when price is too low, it is time to buy; and when it is too high, it is time to sell.
Specifically, the metrics that are expected to mean revert are valuation ratios. These ratios typically look to compare the price of a company's shares relative to its earnings potential or the value of its assets. If an investor can purchase a company that is generating profits, and can do so at a price that is relatively low compared to what investors typically pay for future earnings, this might be a company worth buying. Conversely, the time to sell is when the the price for future earnings is too high. In this way, the cycle of mean-reverting valuation ratios mirrors the cycle of investor sentiment: just as the time to buy from a sentiment or psychology perspective is when the market as a whole has crashed and investors have engaged in panic selling, the time to buy for value investors is when the market has crashed and is discounting the price of future earnings too much.
Value investors typically (but not always) hold stocks for 3-5 years, if not longer. This is often how long it takes for big shifts in valuation ratios to occur. Moreover, statistically speaking, the biggest moves in the market occur on just a few days -- and so it is vital to be in the market when those days occur. Committing to holding positions can help ensure value investors are in the market when the moves they are anticipating occur.
Specifically, the metrics that are expected to mean revert are valuation ratios. These ratios typically look to compare the price of a company's shares relative to its earnings potential or the value of its assets. If an investor can purchase a company that is generating profits, and can do so at a price that is relatively low compared to what investors typically pay for future earnings, this might be a company worth buying. Conversely, the time to sell is when the the price for future earnings is too high. In this way, the cycle of mean-reverting valuation ratios mirrors the cycle of investor sentiment: just as the time to buy from a sentiment or psychology perspective is when the market as a whole has crashed and investors have engaged in panic selling, the time to buy for value investors is when the market has crashed and is discounting the price of future earnings too much.
Value investors typically (but not always) hold stocks for 3-5 years, if not longer. This is often how long it takes for big shifts in valuation ratios to occur. Moreover, statistically speaking, the biggest moves in the market occur on just a few days -- and so it is vital to be in the market when those days occur. Committing to holding positions can help ensure value investors are in the market when the moves they are anticipating occur.
