The goal of this investment approach is to identify undervalued stocks in the market. First, the intrinsic value of a company is determined using fundamental analysis. If a company's market value is lower than its intrinsic value, it is considered undervalued; conversely, if it is higher, it is considered overvalued.
Long-term investment strategy
Value investing involves intensive research, high discipline, and a very long-term investment horizon. The theory is relatively simple, but difficult to implement in practice. Investors who pursue this approach must possess a high degree of self-discipline, sound judgment, and patience.
Value investing does not work in weeks or months but is based on long-term investment decisions. There can sometimes be extended periods of underperformance before the investments begin to pay off. This investment approach could also be called "buy and homework" because regular review of investment parameters is necessary.
Value investors rarely follow the prevailing market sentiment, usually acting counter-cyclically and dispassionately. Good entry opportunities arise especially during times of falling markets or panic.
Contrast – the efficient market hypothesis
Value investors oppose the efficient market hypothesis. The efficient market hypothesis was formulated in the 1970s as a mathematical-statistical theory in economics. According to this theory, financial markets are efficient because all available information is already priced in, and therefore no market participant is able to consistently generate above-average profits through technical or fundamental analysis. This theory states that actively searching for undervalued stocks is pointless, as the market prices all securities correctly at any given time.
There are three versions of the efficient market hypothesis:
- Weak efficiency of information hypothesis
All past market information is reflected in the current market price. - Moderate efficiency of information hypothesis
All information available in the market is reflected in the current market price. - Strong efficiency of information hypothesis
The current market price also includes non-public market information (insider information).
Fulfilling each preceding level of information efficiency is a prerequisite for fulfilling the next higher level of efficiency.
Therefore, active value investing stands in direct opposition to the efficient market hypothesis.
Author
Günther Kornfellner, CFA, CAIA
Derivate Trader, Bybit EU