My name is Brett Nelson and I’m a contributor and owner of Simplifying Finance. We’re a blog helping people get started understanding their personal finance and investing. Mainly, we focus on Ben Graham/Warren Buffett-style value investing. The good folks at Boomer and Echo here have allowed us to do a guest post, so we’re going to (hopefully) provide some information about value investing for you! Without further adieu, let’s begin.
Protection During the Crash
There’s a crash coming, eventually, there’s no denying that. Looking at the history of the stock market, it’s clear that bull markets don’t last forever. Since 2008, we’ve been in a bull market charging upwards to all-time highs. Obviously, this isn’t going to last forever. So, what can you do to protect yourself?
Value investing is a type of investing that measures the intrinsic value of a company. By calculating what a company is worth, you can be sure to only purchase stocks that are trading below their intrinsic value. This can be tricky, as it requires you to practice patience with your emotions. One of the keys to value investing is not selling off during a dip in the stock’s price, as long as the company’s fundamentals haven’t changed.
Stock market crashes usually occur when the stock market is vastly overvalued. This was especially the case in the late 90s, when tech and internet companies inflated the market to gross levels.
By practicing value investing, you’ll avoid investing in companies that are hugely overvalued. That way, when the market crashes and the price drops, the price of undervalued companies probably won’t drop has hard as overvalued companies. In addition, they’re far more likely to rebound to their intrinsic value. Meanwhile, if a company is overvalued, it is unlikely that it’ll rebound back to that overvalued price.
Think of it this way, if the market crashes, the general price of stocks will drop drastically. If the company is overvalued, that stock is already at danger of crashing on its own. Therefore, once it crashes, it’s going to trade closer to its value. We call this a market correction. The odds of the company going back to the price it was trading at before the crash are slim, as you’re already gambling with an overvalued stock.
However, if the company is undervalued and the price drops more, the opposite is true. Eventually, that company is probably going to trade closer to its intrinsic value. Therefore, if it’s lower, it will probably rise up a lot faster and higher after the correction drives all of the prices down. Keep in mind that this is only if nothing has changed fundamentally with the business.
Value Investing in a Market Crash
The other good thing about value investing is that it’ll help you make money after the crash. I like to think of market crashes as ‘stock sales.’ That is, when the market crashes, all of the stocks go on sale. Believe it or not, this is the best time to purchase stocks!
The key to successfully implementing a value strategy in a market crash is to buy stocks of companies that have great financials. If the company is still making money with little debt and has an effective business model, there’s no reason why it should be trading so low. During market crashes, you can find stocks trading at 20-30% of intrinsic value, what a steal!
Value investing in the crash is a twofold operation. Also consider the companies you purchased before the crash. If these companies haven’t changed financially, there’s no point in selling them off in a panic like everyone else is. Instead, buy more shares! If I see toilet paper on sale, I buy several packages, even if I’ve already got a bunch at home!
Value investing is a great technique to use if you’re risk averse but still want to invest in stocks. Not only will it protect you during the economic downturn, but you can also make a lot of money when the stock market recovers! This is why we’re such strong proponents of value investing; it works in two ways. Keep in mind though, value investing works as a long-term strategy, it’s not a technique to use for day trading or any of those techniques.
If you’re interested in valuing stocks, check out this special offer we have for the audience here: a PDF guide teaching you how to use the Graham Number, a stock valuation technique. Use this calculation to determine the intrinsic value of a stock!