You’ve probably heard of Warren Buffett, right?
He’s one of the richest people in the world. What makes Warren so interesting is, unlike the other richest people on the list who started companies, like Bill Gates (Microsoft), Mark Zuckerberg (Facebook), or Jeff Bezos (Amazon.com), Warren made his money through investing.
That’s an amazing achievement. And you’d imagine it would be nice to know just how he made so much money ($75 billion, by the way) as an investor.
Well, you can, actually! The way he thinks about investing and the way he evaluates an investment is called value investing. There are countless books and entire college courses on just this subject.
So what is value investing?
It’s an attempt to find the “diamond in the rough,” the company that may have fallen on hard times and is not the prettiest girl at the dance. It’s a solid company but is just a little rough around the edges. As a result, the stock price is not as high as it once was or as high as its competitors. Value investors look for good companies that are temporarily on sale.
Or a value stock may be an older and more mature company that just doesn’t have the wow factor anymore. It’s not growing as much as it used to, but it still has lots of customers and produces a lot of revenue. It’s not the sexy high growth company it used to be. It’s now just chugging along, doing its thing, making money.
Some investors like this kind of company. They like that it’s a more mature company that has been around a while. They don’t mind that it’s not growing like crazy anymore. They’re more interested in slow and steady growth from a company that is producing a consistent profit.
In fact, let’s talk about companies and the money they make.
If you’re the president of a company and you’re making a bunch of money, what could you do with this money? Well, if you are eTrade, you could spend $2 million on a Super Bowl commercial that featured a monkey dancing to La Cucaracha. Or maybe you could hire more employees. Or maybe you could use that money for research into a new product. Or maybe you could give some of the cash to the owners of your company, the stockholders. You could do any or all of these if you wanted.
But what should you do?
Well, here’s where it gets interesting. The big question is: what is the best use of this money? For some companies, they think the best use of the money is to reinvest it in their own company by trying to get more customers through advertisements, or producing more products, or getting more highly skilled employees to help the company grow.
On the other hand, some companies are so mature that they think the better use of this money is not reinvesting it in the company – we have enough money, and if we tried to grow, we’d just be wasting the money – so instead, they send some of that money to the stockholders.
The company that sends the money back to shareholders, the one that is more mature, stable, predictable, and is not growing as fast, is called a value company. As a value investor, you’d look for these types of companies to invest in.
What are some examples? Coca Cola. Johnson & Johnson. Disney.
But why are value company stocks more stable and tend to be less risky?
Well, again, they tend to be more mature. They’ve been around longer. They tend to have “better balance sheets.” What does that mean? A balance sheet simply lists what a company owns and what a company owes. A “better” balance sheet means it owns a lot and owes very little. A value company may have more cash on hand. All of these things mean that if the economy declined and people generally slowed their buying, a value company with all that cash and experience might do better than a younger company with less cash and experience.
If that’s a value company, what’s the opposite?
An un-value company? An anti-value company? Nope. It’s a growth company. Well, that sounds quite dazzling. Growth. Who wouldn’t want that? Lucky you. You get to learn about growth companies in the next lesson.
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.