What is Value Investing?
We talk a lot about "value investing". But what does that really mean?
Within the equity markets there are two kinds of participants (i) traders and (ii) investors. Traders are what they sound like, people looking to make money moving in and out of stocks quickly. They may be buying a stock before an earnings announcement hoping for a jump (or a decline if they are short) or day trading based on movements of certain securities. For the most part, they are guessing which way a stock will move. Some people are actually skilled at trading, the majority are not and they lose a lot of money.
The other type of market participant is an investor, which is what we are. Investors seek to value businesses and purchase those businesses at a discount to what they are truly worth. Investors determine what a business is worth by estimating the future cash the business will generate for its owners. It's the same process you would go through if buying a rental real estate property. How much rental cash flow the property generates for its owner determines how much someone is willing to pay for it. If you are looking to buy a property that generates a lot of cash relative to what you pay for it, you doing the same exercise a value investor is doing in the stock market.
Investors typically hold their securities for longer periods of time, months, years, even decades. The taxation system of the United States (and most countries) is designed to benefit investors, not traders. Investors pay capital gains taxes, which if held over a year is typically 15%. Traders who hold less than a year have their gains taxed as ordinary income (say 30%+).
The reason the taxation system is set up this way is to encourage people to “invest in business”. This provides businesses with the capital they need to grow and succeed. You want a system that guides unproductive capital (such as cash) to worthy businesses in need of investment.
This gets to the heart of why capitalism works (i) capital is allocated to the best ideas, (ii) those ideas are able to flourish or fail and (iii) business owners (including the investors who own portions of the equity) are allowed to keep their gains. In many ways just as importantly, failure, at least in the US, is not as stigmatized and the legal structure is set up to allow people to come back from failure through the bankruptcy process.
Capitalism isn’t perfect but it’s better than the alternatives. It's also setup to reward patient value investors.
Within the world of investors, there are typically two designations (i) value investors and (ii) growth investors. Tune in next time to learn about the differences between both.
All the best,
Your Fortis Capital Management Team
PS - The starter book Warren Buffett recommends on value investing is The Intelligent Investor.