Value Investing Part I: The Basics

Value Investing, for all intents and purposes, is the only method of investing (if executed properly) that promises long-term investment success.

Investment Defined

Before I define and explain value investing, let us first consider the definition of an investment. Benjamin Graham, in his classic investment treatise "The Intelligent Investor", defines an investment as follows:

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return."

The act of simply buying a common stock does not qualify one as an investor. According to Graham's definition there are several criteria that must be met. We have to thoroughly analyze the stock. After such analysis, we must concluded that we have a low probability of permanently losing money and a high probability of generating a return that exceeds a threshold. We'll call the threshold our opportunity cost, i.e. the return we could realize on other investment options.

Price vs. Value

There is a distinct difference between price and value. Warren Buffett says:

"Price is what you pay, value is what you get."

The decision to buy or not buy a common stock boils down to two numbers, the price of the stock and value of the stock. Price is easy, it is given to us in minute-by-minute market quotations. At any given moment, price is a specific and known number. Value is a bit more tricky. It is the number we hope to arrive at following "thorough analysis." Determining value is a tedious, yet imprecise, task. We will discuss the process of valuation later in the series.

Value Investing is simply buying stocks, or other assets, for less than their value.

Investing is as simple as that statement; determine the value of a stock and buy when the price is less than value.