In this series, I will show investors how to find and analyse new value investment opportunities. So what are these? Let's start with a definition:
A value opportunity is one where there is a perceived difference between the fundamental value of the underlying business and the price at which the market currently offers the investor the opportunity to purchase a share of that business.
Many investors will use additional tools in their stock selection. For example, they may conduct a balance sheet analysis to minimise the risk of bankruptcy or use charts to time their entry into a stock. However, such factors will always be secondary considerations that value investors use when they believe they have identified a significant difference between valuation and price. Conversely, a value investor will never buy into a company they believe to be overvalued, no matter how strong the management team or the stock's recent price action is.
The start of value investing
The idea that valuation should form a major part of choosing to invest in a business may seem pretty standard today, but it wasn't always the case. Benjamin Graham is often considered the father of Value Investing. When Graham and David Dodd wrote their 1934 book, Security Analysis, the market orthodoxy was that investors should choose their investments based on how revolutionary a company's idea was or how the chart looked. These factors often led to the manias, booms and busts.
For example, in the 1840s, there was a UK stock bubble known as the Railway Mania. Modern investors know the pattern by now. Railways were a genuinely new technology that excited investors. As speculators drove up the price of railway stocks, more and more money was invested in the sector. This led to many new companies being formed and raising capital to build new lines. 263 Railway companies were formed in 1846 alone. About a third never completed their lines, and some were fraudulent attempts to take advantage of the enthusiastic investor sentiment. Even those companies that saw their projects completed were not spared the brutal sell-off as the bubble burst. Ultimately, the UK gained a great deal from the development of the railways. However, in a pattern repeated in almost every technology bubble since, investors in the technology were not the ones to benefit.
Instead of joining in the manias, Ben Graham took advantage of them. By conducting a rigorous…
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