One of the more important concepts to keep in mind when investing is the difference between price and value.
Simply, price is what you pay for something, or what the market thinks something is worth; value is what you think it is worth.
From this underlying principal two theories of investing arose - value investors and (day) traders.
What is Value Investing?
Investing for value is the belief that some companies are mispriced by the market due to overreactions by the market.
Value investors are generally interested in the company for the longer term, seeking stocks that have strong fundamentals such as cash flow, traction, earnings, and dividend reports, which are not fully priced into the stock.
“If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.” - Warren Buffett
Importantly, value investing does contradict the efficient market hypothesis (EMH) - the belief that the market price always reflects all available information, and therefore it is impossible to "beat the market". There are, however, a number of opponents of the EMH, most notably Warren Buffet.
Value investors each have their own criteria of what to look for when investing, however some general guidelines are shown below. For more information on value investing we recommend researching "the father of value investing" Benjamin Graham.
- Low debt / equity ratio
- Low price / earnings ratio
- Low price / earnings to growth ratio
- Low price to book ratio
- Positive earnings / share growth
- Currently paying dividends
Generally, these statistics are most useful when compared against companies in the same industry, as different industries can have different expectations of norms for these statistics. Additionally, the maturity of the company may impact the norms of these ratios.
What is Day Trading?
Like value investors, day traders also believe that the EMH is inaccurate, and that the market can be slow to react to global news flow.
However, unlike value investors, day traders do not have a long-term view when looking at investments, instead purchasing shares that they expect to be able to sell shortly, for a profit. Day traders are attempting to predict future market movements and make their stock purchases accordingly.
In order to be successful, day traders often make assumptions about upcoming news flow - either from the company or globally, and purchase shares prior to potential price changes. For example, a day trader might purchase shares prior to the release of:
- A report on a country's manufacturing levels
- A report on an importer's level of demand
- The company's mineral report
- The company's presentation at an event
Additionally, day traders often look at overall market trends, economic sentiment, and market confidence before making their purchasing decisions. As such, day traders are generally more interested in the price of the share rather than the underlying value of the company.
Whilst day trading attracts a lot of attention, probably because of the occasional story of individuals succeeding, it also attracts substantial criticism.
Notably, most criticism is aimed at its usability as a long-term strategy for investing, as there has yet to be an investor who has been titled the "Warren Buffet of day trading".
The volatility of the market also impacts day traders, and they can win big one day and lose everything the next. Interestingly, research has shown that frequent trading leads to lower returns.
Broadly, value investors purchase companies for the long haul, whilst day traders purchase shares to flip. The style of investing you choose needs to correlate with your overall investing strategy. Can you afford to make bets and lose each day? Or are you interested in acquiring wealth over a medium-long period of time? Deciding on an investment strategy is the first step to take before investing.
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