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The stock market can be a complex place. So where should you start? In order for anyone to find success in anything, we must first learn the basics. This post is the first of a 3 part series detailing the 9 most important value investing basics. Today’s post will cover 3 tips for the absolute basic fundamental strategy, successful value investors follow for stock market profits.

The other 2 parts of this series will cover…

• 3 Tips For Maintaining Your Portfolio. Detailing how you stay up to date with your stocks and best use your profits for future gains.
• 3 Tips For Reducing Risk In The Stock Market. Detailing 3 useful strategies you can use to make sure your investments are of small risk to lose you money.

This series is aimed at teaching you the fundamental strategies great value investors such as Warren Buffett and Phil Town use to invest in the stock market. The basics is a great place to start. Once you can understand these 9 tips, you will be primed to dive into the greater details of value investing. Be sure to check out the Stock Market page of the Money Your Concern website to find out more.

So without further ado, find below 3 fundamental skills you must learn to become a successful value investor. I hope you find this to be of great value to you.

1.Invest In Good Companies At A Cheap Price:

So what makes a good company? 

In short, there are lots of factors that go into selecting good companies. Factors which will eventually fill up the stock market section of this website in time as I dive into more detail. Although, the basics are that a good company is one which is profitable and will continue to be even more profitable in future. They must be well run, with a smart and forward thinking management. They must be smart with their finances and not be overwhelmed with debt.

To find all of this information, you must be comfortable with reading financial statements, annual reports and check up on many other external resources to grab opinions and knowledge of how the company is run and where it is going. All of this information will be detailed in future information put out on this website.

I won’t lie to you, all of this does take a lot of work. It gets easier the more you learn but for beginners, there is something I’d recommend you stick to to begin with. To make your learning process easier.

A tip for beginners…

A useful tip for beginners would be to look at larger well known companies. In the UK, this would mean looking for companies in the FTSE 100 and possibly in the FTSE 250 indexes. These companies have a lot more capital and already will have a large and loyal customer base. Larger companies tend to be more stable and more likely to still be standing during an economic downturn.

So although these larger companies will offer less upside potential. Most of these companies are large for a reason. They are often well run and will still have a business even in difficult times. With these companies, you are much less likely to lose a lot of money, if you make a mistake by choosing the wrong stock at the wrong time. 

Once you learn more and become more confident wit investing in the stock market. You could then look to the higher risk but greater reward opportunities that the smaller, faster growing companies can offer.

Expanding on this… 

There is more to stock picking than simply choosing good reliable companies with future growth prospects. The fundamental factor of value investing basics is buying good stock at a discount price. This means we must analyse the current and future performance of the stock relative to its price.

The simplest formula frequently used to find the value of a stock is the price to earnings ratio (P/E ratio). The equation for which is shown below.

P/E ratio= Share Price/ Earnings Per share

This means the stock price is compared to how much profit the company is making relative to how many shares are issued by the company. 

As a rule of thumb, a P/E ratio of <15 is considered cheap. However, it is important to mention a cheap P/E value of a company varies between different sectors and companies. For example, if a company is expected to have earnings much higher in future, a higher P/E can be considered cheap. There will be another future post going into more detail on this…

The general essence of value investing is, if you can choose a good company at a cheap price, the stock price will eventually bounce back to its fair value. This will give you a tidy profit. 

2. Cost averaging:

Building from the last point, when buying shares in a company it is important to not invest all of your money at once. Even if you choose great companies, in the short-term your stock picks are likely to fluctuate up and down. It is good practice to buy a stock with part of your savings and hold some back. If the price drops in the short term which isn’t to do with any bad news about the future of the company, buy more and you will average down the price you paid for that stock. When the stock bounces back, you will make even more profit than had you bought all-in on the higher price.

This is called pound cost averaging. Drip feeding your purchasing like this cancels out the issue of fluctuating prices by averaging out the cost over a period of time. Nobody can predict the short-term volatility of the stock market. This is why it is such a great idea in order to reduce your risk in the stock market. 

If you are lucky and the share price bounces back immediately after you buy in, obviously there’s no reason to be upset about this. As long as the shares are still of cheap value, you can buy more. If not, you may want to look for other stocks you either already own or are watching. See if there are any bargains to be had there with your left over cash. 

3. Buy Low, Sell High:

I know this is an obvious one. However, in reality this is much easier said than done. Due to the volatility of the stock market and the fact that we are playing with our real money, emotions get involved. The biggest reason people lose money in the stock market is because they can’t control their emotions. Inexperienced investors often buy in at a high price because they see the price is shooting up and they don’t want to miss out. Oppositely they sell as a price is dropping because they are afraid it will go to zero. This is why it is important we don’t let emotions get in the way. We should stick to value investing basics, regardless of what the market is doing.

So the value investing basics are to buy when a stock is cheap or the company’s future looks increasingly good. Then you look to sell once it is starting to get expensive or the company’s future looks not as good anymore.

Remember the point number 1 made?

So we know the value investing basics for knowing what a cheap stock is. Can you guess the method we can use to work out whether a stock is now expensive?

Well there are more than one factor to look out for but if you said the P/E ratio, well done. Although there are many other factors which are important for you to learn about in valuing a company, P/E ratio is a good place to start. Once you’ve acknowledged the fair P/E ratio of that particular company, it’s important to buy below this level. You can then look to sell off once the value goes significantly above this mark. 

The only thing that can justify a high P/E ratio is if there are great future earnings prospects for the company. This means earnings of the future will bring down this P/E value. If there seems to be no justification for the high price relative to the companies current or future earnings per share, then more often than not, at some point the price will correct and the share will drop in value to a more fair valuation. This is particularly the case during a recession.

Don’t forget to check out part 2 and 3…

Thank you for reading, by now you should have a grasp on the basic concept of value investing. However, a successful stock market investing method doesn’t stop there. I recommend you check out parts 2 and 3 for a more complete view on value investing basics. After which you will have a good understanding on what a successful stock market investing method looks like. 

Once you have the basics, you can then dive deeper into how to choose good companies. You will also have a better perspective on when and the reasons you need to buy and sell a stock. Be sure to check out the investing section of the Money Your Concern website to get as much knowledge as you can to be a successful investor.

This is the main strategy I use to invest which will supplement my £1 a day challenge journey. Helping me to reach financial freedom. I hope this post has inspired you to further your investing knowledge and gain a little financial freedom in your life too.

Best wishes on your financial journey,

Harry