Investing to Achieve FIRE – Stock Investment Edition｜What is Value Investing in Undervalued Stocks?
Are you familiar with "Value Investing," one of the many methods of stock investment?
To put it simply, Value Investing means "investing in stocks that are priced lower than usual." It is widely known as the investment style of the renowned investor, Warren Buffett.
This method is characterized by a low risk of price decline and a high probability of price appreciation in the long term.
In this article, I would like to explain the overview of Value Investing, how to find undervalued stocks, and the pros and cons of this strategy.
▪What is Value Investing?
Value Investing is a method of investing in stocks that are considered to be left "undervalued" because the profits generated by the company or the value of the company itself are not properly assessed by the market.
It is also known as the investment style of the famous investor Warren Buffett.
It involves calculating the appropriate stock price from the analysis of a company's financial statements, purchasing it at an undervalued timing, and holding it for the long term.
By investing in stocks that remain undervalued, there is a possibility of making a profit when the stock price returns to the level where it should originally be valued.
To find undervalued stocks, it is necessary to calculate the "Intrinsic Value" of the company. In the next section, I will explain two important indicators for this calculation.
▪What are the Indicators to Find Undervalued Stocks?
To succeed in Value Investing, you must be able to judge whether a company's stock price is cheaper than it should be.
Here, I will introduce two representative indicators essential for finding undervalued stocks.
• PER (Price-to-Earnings Ratio)
• PBR (Price-to-Book Ratio)
1. What is PER (Price-to-Earnings Ratio)?
PER is an indicator for measuring a company's earnings value and is expressed by the following formula:
PER = Share Price ÷ Earnings Per Share (EPS)
PER indicates how much value the stock price has relative to the company's earning power.
If the PER is low, the stock price is often considered undervalued relative to the company's profits, which can be seen as an appropriate timing for Value Investing.
However, caution is needed because a PER that is too low may indicate that the market estimates the company's future growth or earning power to be low.
On the other hand, a high PER indicates that the company's earnings growth is expected, or the market evaluation is high.
However, if it is excessively high, it can be perceived as a potential bubble.
2. What is PBR (Price-to-Book Ratio)?
PBR is an indicator for measuring a company's asset value and is expressed by the following formula:
PBR = Share Price ÷ Book Value Per Share (BPS)
PBR indicates whether a company's stock price is overvalued or undervalued relative to its net assets.
If the PBR is less than 1, it means the stock price is valued lower than the company's net assets.
Therefore, investors who emphasize asset value can judge it as undervalued.
If the PBR is 1 or more, the stock price exceeds the net assets, suggesting that the company is valued for non-asset values such as profitability and growth potential.
In Value Investing, which emphasizes asset value, choosing companies with low PBR can lead to expected returns due to stock price corrections.
▪Pros of Value Investing
If you can acquire undervalued stocks using the indicators mentioned above, you can expect the following benefits:
・You can buy stocks at a bargain price
・Since it is undervalued and neglected, the risk of further stock price decline is low.
・Potential for dividend income
・It has the potential to increase in value over the long term.
1. Acquire stocks at a bargain Value
stocks are typically shares of companies valued lower than their intrinsic value.
By purchasing with an eye on the company's financial status and future growth, you can start investing at a discounted price.
2. Relatively low downside risk
Since they are traded at a discount, the risk of a significant price drop is often low. Also, since you are purchasing at an already low stock price, it can be said to be a relatively safe investment strategy.
3. Potential for dividend income Value
stocks are often mature companies, which may provide stable dividends.
This can make them attractive investment targets for investors expecting regular income.
4. Potential for long-term value appreciation
There is a possibility that the stock price will rise when the market re-evaluates the company's value.
By investing over the long term, chances of gaining profit increase.
▪Cons of Value Investing
While Value Investing is attractive even for beginners and those starting with small amounts, it is important to understand the following disadvantages:
・It's not easy to decide on an investment target.
・There is a possibility that stock prices may not recover from their low levels.
1. Choosing investment targets is not easy
Value Investing is a method of buying stocks when the stock price (market capitalization) is undervalued compared to the company's intrinsic value.
However, "easier said than done"—knowing what a company's intrinsic value is is not simple.
It requires judgment considering not only low PER/PBR but also the company's financial situation.
It is also necessary to consider other factors affecting stock prices (e.g., interest rates, economic conditions, competitive landscape).
2. Possibility that the stock price never recovers
If the reason the stock price is undervalued is due to fundamental problems (e.g., industry decline), the company's growth potential may not improve, or business performance may worsen further.
A situation where a stock looks undervalued but actually continues to stagnate without recovering its value is called a "Value Trap."
When investing simply because the stock price seems cheap, it carries the risk that the cheapness is not temporary, and the value may drop even further.
Summary
In this article, I explained "Value Investing," a method to find undervalued stocks. When starting to invest, many people think, "I want to get a big return with small capital."
Value Investing is an attractive method that fits this idea perfectly, but it comes with disadvantages.
The basic principle of investment, "Buy Low, Sell High," is simple but a typical example of "easier said than done."
I explained the outline of PER and PBR, but just knowing them makes it difficult to succeed in investment immediately.
However, I wrote this article hoping it would be a trigger for you to step out of judgment criteria such as "Buying because others are buying" or "Buying because others say indices like the S&P 500 are safe."
I hope that knowing the basic knowledge will help you establish your own rules and standards. (Text by Julius)
About the Author Kenji Kamioka
CEO, Julius Inc. / FIRE Practitioner
Kenji Kamioka is a former IT executive who spent 30 years in the corporate world, with over 10 years working across Asia. His life changed when he read Rich Dad Poor Dad.
Realizing the trap of the "rat race," he started building assets in real estate and stocks while still working. It took him 10 years, but he successfully achieved Financial Freedom and graduated from the salaryman life.
He established his own asset management company to optimize tax efficiency and now dedicates his time to teaching others how to escape the corporate cage.
His advice is not theoretical but based on the gritty reality of achieving FIRE.Credentials: AFP (Affiliated Financial Planner), Certified Real Estate Transaction Agent.
Book
❶『令和のサラリーマンの為のFIREのススメ』(Amazon電子書籍）
❷『FIRE Recommendation for Office Employee』(Amazon Kindle）
