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Value Investing entails selecting and buying stocks with strong fundamentals such as earnings, dividends, book value, and cash flow that are priced at a bargain when their quality it taken into account. Value investors research and try to select companies that they believe have been incorrectly undervalued by the market. Hence, they believe that if they buy these undervalued companies, the share price of these companies have the potential to increase once the market realizes its error. There are a number of guidelines that you must consider following if you decide to use value investing as an investment strategy. These are as follows: 1. Invest in companies whose stock prices are not high relative to their average earnings over a number of years. 2. Invest in companies that are large, prominent, and conservatively financed. 3. Invest in stocks whenever there is a sharp decline in the stock market. 4. Invest in companies that are part of industries that lead the decline in the stock market. 5. Invest in stocks but don’t get sidetracked by temptations. 1. Invest in companies whose stock prices are not high relative to their average earnings over a number of years. This guideline entails closely examining the price-to-earnings ratio (P/E). According to Benjamin Graham and others who have studied the effects of the P/E historically, a number of points can be made. a. First, avoid investing in stocks when the market P/E is high (i.e. higher than 20). b. Before you invest in a stock, examine the company’s P/E over a number of years. Study its price in relation to its earnings over the past 5 to 10 years. Looking at just recent earnings may result in you coming to erroneous conclusions because of short-term factors that give a company an exaggerated or underestimated P/E figure. c. When the ratio is low it is good time to invest. d. When the ratio is high it is not a good time to invest. Many investors who have achieved success have used the P/E as the fundamental core of their strategy. One of the most noteworthy is John Neff who has successfully managed the billions of dollars via the Vanguard Windsor Fund over a period of 30 years. 2. Invest in companies that are large, prominent, and conservatively financed. The reason you should follow this principle is because it is easier to invest in larger more prominent companies because they invariably have track records spanning many years. In addition, their financial statements are more reliable than those of smaller and lesser-known companies that have not been around for a very long time. Thus, larger companies on the whole are much less riskier to invest in than smaller companies. In order to determine whether or not a company is conservatively financed, you should examine how its short and long term debt levels stack up against its total assets. This entails calculating its debt-to-equity ratio (D/E). The D/E is calculated by dividing a company’s total liabilities by the equity held by shareholders (total liabilities / shareholders equity). It is important to note however that when applying this principle (as with others), you should use a fair amount of judgment. Just because a company is large and prominent does not necessarily mean that it is financially sound. It might have very complex business operations that are not clearly articulated, and thus make analysis difficult. Also, sometimes it may be difficult to determine whether a particular company can be regarded as prominent. 3. Invest in stocks whenever there is a sharp decline in the stock market. Whenever there is a sharp decline in the stock market, there are usually some good investment opportunities to take advantage of. Experienced investors have made the argument that whenever there is 20 percent decline in stock market prices, you should increase your investments in the stock market. The amount you invest of course depends on your risk tolerance. In this circumstance, it is important to note that it is not the decline in prices on its own that is the key factor. Rather, it is how the price of a stock relates to the earnings of the company. For example, if the P/E in the long-term has been calculated to be 20, a decline in prices to a point where the P/E is 15 may indicate that there are some opportunities that should be considered. It is particularly important that this guideline should be used in the context of a longer-term investing strategy. 4. Invest in companies that are part of industries that lead the decline in the stock market. Over time, when the stock market has declined by 10 or 20 percent, this decline has been led by one or a few industry sectors. Those industry sectors that led the decline in prices in the stock market, have also often led the way when the stock market recovered in value. As a result, companies with good fundamentals in the aforementioned industry sectors are worth investigating as opportunities for investment. 5. Invest in stocks but don’t get sidetracked by temptations. Using value investing as an investment strategy does not mean that you should buy a stock just because the company’s stock price falls and its price is cheap relative to what it cost just before the price fell. You must be careful of stocks that may look like a bargain. Dig deeper. Kmart for example, was one of those stocks that looked like a bargain in the 1990s. However, Kmart was a low-quality company when compared to Walmart, which was in the same industry sector. The price of Kmart kept falling and never rebounded, and eventually the company went bankrupt in 2002. So, it is important when using the aforementioned guidelines that you also always play close attention to the fundamentals underlying the company you may be thinking of investing in. 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