Value investing: what is it, why it works and how to do it

You must have a robust methodology for selecting the right share, property or bond to invest in. If you select the right asset, your investment returns are likely to be very healthy in the long run.However, if you make a mistake, it is likely to cost you money – in terms of opportunity cost and/or in real terms.The best way to prevent making a mistake is to use a methodology for selecting the right asset that is proven to work. In this blog I outline the four different methodologies and the two that I think are best to use in combination, where possible.There are four different asset selection methodologiesThere are many different asset selection approaches which can have their own subtleties and idiosyncrasies. However, every methodology can be broadly allocated into four different categories:1. Value investingThis involves identifying assets or sectors that are intrinsically undervalued. Markets are not always perfectly efficient and sometimes assets transact for amounts less than fair market value. This could be due to factors such as a motivated seller, misinformation, market sentiment (fear) and so on.2. Growth investingThis involves identifying assets or sectors that have high growth prospects. This approach is less concerned with the price paid for the asset compared to its appraised value - it’s all about the idea that you can buy this asset today for $x and that price will look cheap in the future after the expected growth has materialised. This methodology requires you to form a view as to what the future growth opportunities could be which is often highly subjective.3. Fundamental investingThis approach involves identifying the assets or sectors that have the strongest underlying fundamentals such that the asset quality is extremely high. This approach is less concerned about the price paid and usually the assets growth prospects might be already reflected in the current price. The thesis underlying this strategy is that investment returns are directly linked to asset quality i.e. you can only expect above average returns from above average quality assets.4. Technical analysisThis approach involves looking for trends in data and statistics (such as price movements and volume) to identify assets and sectors that are expected to deliver above average returns in the short or longer termFundamental with a value tilt, if possibleThe lowest risk approach by far is fundamental investing. Asset quality will typically persist longer than market mispricing or unrecognised growth prospects. As Warren Buffett says, he would rather buy a wonderful stock at a fair price than a fair stock at a wonderful price.However, sometimes it is possible to employ both a fundamental and value approach. That is, for example, sometimes you can buy a wonderful property or stock for a wonderful price. But, you must never pursue a value approach at the cost of the investment’s fundamentals. That is, never compromise on asset quality.You can reduce your risk by using an evidenced-based approachAn evidenced-based approach involves only adopting an asset selection methodology where there is overwhelming evidence that it will produce the desired investment returns. Too many people adopt investment methodologies and approaches without considering whether the evidence stacks up and that is just too risky – it is totally unnecessary to take that risk. Therefore, if you want to find a fundamental approach to adopt when selecting the right residential propertMy new book is available for pre-order now: Pre-ordering the book will help me get it into bookstores. So please do me a favour - please consider pre-ordering now - links and pre-order bonus are available here: https://prosolution.com.au/book-preorder-bonus Do you have a question for the podcast? Email us at [email protected]. If you're interested in working with our team and me, discover how we can work together here: https://prosolution.com.au/family-office-servicesIf this episode resonated with you, please leave a rating on your favourite podcast platform. Subscribe to my weekly blog: https://prosolution.com.au/stay-connected IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.