2 Keys to Successful Value Investing
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When it comes to investing money in stocks, there are 2 keys to success for value investing. The vast majority of investors tend to be shortsighted. And the market as a whole is largely focused on just making a quick buck. Yet, history has shown that the most successful investors are those which take a long-term approach. In the long-term, no one can predict the future. But there are certainly steps you can take in terms of upfront research and due diligence to minimize risk and maximize long-term investment returns.
Why Long-term is Preferrable to Short-term
To maximize investment returns, investing for the long-term is far more preferrable than doing so with a short-term focus.
Taxes are the first reason to approach investing with a long-term focus. Of course, the primary reason to invest money is to make a profit. Investing money is useful in terms of money management and wealth creation. But any asset that you acquire and then sell at a price that's greater than what you paid is subject to taxes. It's called a capital gain tax. And how much you pay in capital gains tax will depend on how long the asset was held.
Assets held for less than a year are subject to ordinary income tax rates. However, assets held longer than a year are taxed at a lower rate of 0%, 15%, or 20%, depending on your income. The more buy/sell transactions incurred with capital gains, the more that is paid in taxes. Holding investments for the long-term is the best investment strategy to minimize taxes and help maximize returns.
Investing money with a short-term focus removes the powerful effects afforded from compounding. You want your investments to leverage the effect of compounding returns. The Power of Compounding is strong, and it can generally be deployed simply by implementing a "buy and hold" investment strategy. This is largely afforded only after having identified businesses with excellent long-term economics though.
Instead of cashing out on strong investments with short-term profits, let those profits remain with the company. If the company is one that is generating long-term, above-average returns, then you're effectively reinvesting your short-term profits with a compounding effect. As long as you leave the difference invested, then your returns have the opportunity to compound over time.
Two Keys to Value Investing
The price paid will will certainly be a big part in dictating the return on investment. With inflation on the rise and a lot of economic uncertainty abounding, fears of an economic recession are looming. As a result, market jitters tend to cause short-term investors to sell their holdings and cash out on gains. This drives the prices of stocks down, creating buying opportunities for shrewd value investors.
Buy at Attractive Prices
So, the first key to success in value investing is to buy stocks at attractive prices. Buy on the dip! Because the vast majority of the stock market suffers from occasional pessimism, the opportunity to buy some of the greatest companies at discount prices arises. Oftentimes, the stocks of such companies have fallen out of favor with investors due to temporary issues related to the economy or the industry. Little attention is paid to the underlying fundamentals of the companies themselves. As long as core fundamentals remain strong from a long-term perspective, falling stock prices present buying opportunities.
Buy Companies with a Durable Competitive Advantage
The other key tactic to value investing is identifying companies with a durable competitive advantage. Not only do you want to buy at an attractive price, but you want to make sure the investment is a quality one. Investments in stocks should be made in companies with durable competitive advantages that will allow their stock prices to be pulled out of any bad-news situation causing short-term investors to be pessimistic.
Companies with durable competitive advantages typically sell a brand-name product or service and hold a market-leading position in their industry. There are high barriers to entry. The resources required to effectively compete against such a company are nearly insurmountable. Such companies have significant pricing power with the freedom to raise prices due to strong consumer demand and no available substitute products. These type of companies have the greatest potential for long-term economic growth. And finding them at discounted prices will help maximize returns.
Value investing with a long-term focus affords many benefits and the highest potential for returns. Investing money in the stocks of companies with competitive advantages is ideal. Such companies typically have strong brands with serious pricing power and the ability to earn monopoly-type profits. They have the ability to withstand temporary economic downturns, short-term market jitters, and competitive attacks. Identifying opportunities to buy into such companies at attractive prices is key to maximizing returns over the long-term, avoiding capital gains taxes and allowing the effects of compounding to manifest.
The information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions. I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website. I also may own stock in all of the aforementioned companies.