2 min

How to Practice Value Investing

Aug 25, 2022
in a nutshell
  • Value investors hunt for firms whose stocks currently trade below their intrinsic value, and that have the potential to bounce back.
  • Growth and value stocks tend to perform differently under different market conditions.
  • Rather than trying to choose between growth or value stocks or attempting to time performance, investors would be smart to hold some of each style.
Image of Warren Buffet shares tips on how to practice value investing and how to add value to your portfolio.
in a nutshell
  • Value investors hunt for firms whose stocks currently trade below their intrinsic value, and that have the potential to bounce back.
  • Growth and value stocks tend to perform differently under different market conditions.
  • Rather than trying to choose between growth or value stocks or attempting to time performance, investors would be smart to hold some of each style.

Every year, Warren Buffett releases an annual letter to Berkshire Hathaway shareholders, filling his investors in on the financial goings on at the company and reflects on the choices he’s made over the years. The letters make for important reading if you want to be more like the undisputed champion of investing.

In the 2021 note, one piece of information made a lot of investors’ ears perk up. Buffett is holding cash, and a lot of it. How much is a lot for a company valued at more than $700 billion, you might ask? At the moment, a whopping $144 billion.

Buffett explains that he always keeps at least 80% of his net worth invested in stocks and prefers that number to be closer to 100%. “Berkshire’s current 80%-or-so position in businesses is a consequence of my failure to find entire companies or small portions thereof (that is, marketable stocks) which meet our criteria for long-term holding,” he wrote.

The criteria Buffett refers to — the basis of his investing philosophy — hinges on the idea of buying good companies at an attractive value. If you have a diversified portfolio, chances are you already own some “value” investments. If you want to hew your portfolio closer to Buffett’s, however, it might be time to add more. Here’s how.

How to handle investments and cash

Berkshire always has at least some cash on hand, Buffett notes in the letter: He and partner Charlie Munger have pledged to always keep at least $30 billion in reserve. The duo want Berkshire Hathaway “to be financially impregnable and never dependent on the kindness of strangers (or even that of friends),” Buffett told his shareholders.

“Both of us like to sleep soundly,” he added, “and we want our creditors, insurance claimants, and you to do so as well.”

Financial experts say you’d be wise to adopt a similar policy. Most recommend that you have at least three to six months’ worth of living expenses tucked away in an emergency fund. In doing do, you lower the possibility that an emergency, such as a sudden job loss or a surprise medical bill, could derail your finances by forcing you to tap your investments, borrow, or run up debt to cover your losses.

Buffett doesn’t only carry cash to cover emergencies. He holds it for periods when he’s searching for a good deal — a strategy that many market watchers refer to as having “dry powder.”

On a basic level, you can mirror this by holding some cash and deploying it when markets, or a particular stock on your watchlist, sinks to a target level, suggests Peter Pallion, a certified financial planner and founder of Master Plan Advisory in East Norwich, New York.

“Pullbacks offer a nice buying opportunity for investors, assuming they kept some dry powder in their portfolio,” he says. “If you went to the supermarket today and you saw that hamburgers were half off, would you run out screaming? Or would you buy 10 and stick them in your freezer?”

How to practice value investing

Buffett is looking to buy stocks when they’re cheap, but his strategy goes beyond buying stocks he likes when prices dip. Rather, Buffett is a value investor, carrying on an investing style popularized by his mentor, Benjamin Graham.

Unlike growth investors, who invest in companies they expect to prodigiously boost their earnings in the future, value investors hunt for firms whose stocks currently trade below their intrinsic value, and that have the potential to bounce back.

Finding those companies requires the investor to examine the firm’s fundamentals, and there are plenty of ways to assess whether a firm trades expensively or on the cheap. Perhaps the most prominent is comparing a stock’s current share price to a fundamental measure such as projected earnings or cash flows. Stocks with a low price-to-earnings ratio are thought to be undervalued, especially if their P/E is lower than it’s been historically, or if it compares favorably to peer companies.

Growth and value stocks tend to perform differently under different market conditions. Generally speaking, growth stocks will shine in optimistic markets, but have farther to fall during sell-offs. Value stocks may lag when the market is going gangbusters, as investors flock toward flashier names, but they tend to offer steadier performance when markets get choppy, supported by their often more-generous dividend payments.

How to add value to your portfolio

Growth stocks have dominated the market for the past decade or so. In the 10 years ended March 1, the S&P 500 Growth index returned an annualized 12.49% compared with an 8.05% return in the S&P 500 Value index.

If you type “growth versus value” in your favorite search engine, you’ll likely find as many articles touting a return to value outperformance as you’ll find questioning if value investing is dead forever. For what it’s worth, value has been better so far this year, with the index posting a 4.9% loss so far in 2022 compared with a 14% slide for its growth counterpart.

Rather than trying to choose one or the other or attempting to time when one will deliver better performance, investors would be smart to hold some of each style, experts say. “It’s really important to have a balance,” says Leon LaBrecque, a CFP and head of planning strategy at Sequoia Financial Group in Troy, Michigan.

“I think of value like a vending machine that will kick out money to me every day,” he adds. “But you need growth for your future as well. It’s nice to own [an industry-leading stock]. It’s even nicer to try to own the next [one].”

If you’re currently heavily invested in an index fund, you’re likely tilted toward growth. Run down the list of the biggest companies on the market and you’ll make it to No. 8 — Buffett’s Berkshire — before you find a value stock.

“Although funds tied to the S&P 500 are considered ‘core’ investments, they’re more slanted toward growth because the index is market cap-weighted,” says Todd Rosenbluth, director of ETF and mutual fund research at CFRA. “If you wanted to tilt more toward neutral — especially if you’re worried that growth won’t dominate over the next few years as it has over the last several years — adding some value exposure can provide a counterbalance.”

The easiest way to do that, Rosenbluth offers, is to add a value stock ETF. If you’re an index investor already, he says, make sure that you buy the value version from the same fund family you already own, for instance, adding the Russell 1000 Value ETF if you already own a fund that tracks the Russell 1000. “That way, you’re tilting from your core and not something different.”

The views expressed are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.

This content is for informational purposes only and is not intended as investment advice. The strategies and investments discussed may not be suitable for all investors. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions.

This material has been presented for informational and educational purposes only. The views expressed in the articles above are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses. Article contributors are not affiliated with Acorns Advisers, LLC. and do not provide investment advice to Acorns’ clients. Acorns is not engaged in rendering tax, legal or accounting advice. Please consult a qualified professional for this type of service.

Ryan Ermey

Ryan Ermey was a senior reporter for Grow.

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