Finding real values can be tricky. I know. In January 2001, I learned a painful lesson about investing that I would never forget.
I was working for an investment information company and watching stocks every day. I saw that Lucent
Anyway, my so-called bargain stock just kept swooning. I had caught a "falling knife." What had seemed like a steal at $15 a share is now trading at less than $3 a share. I had judged "value" based only on price. I knew little about the underlying fundamentals of Lucent's business.
I painfully resolved there and then that I'd never buy another stock without understanding the company and its viability. As I've come to learn -- after studying master value investors like Warren Buffett and his mentor Benjamin Graham -- that's the right way to invest.
If you're a value investor, your profit is essentially "baked into the cake" from the minute you buy a stock. That's because you're buying stocks when they're trading for less than you figure they're worth. Profiting is simply a matter of waiting for other investors to realize a particular stock is undervalued. Buying that valuable cake is a very certain way to make money -- far more so than buying Lucent and crossing your fingers.
Value investing works
Sure, buying the next big thing -- a company in a revolutionary industry such as biotech or nanotech -- can sometimes lead to huge profits. The problem is that in aggregate, those sorts of "growth" stocks don't do as well as "value" stocks over time.
Value stocks returned an average of 12.6% annually from 1926 to 2002, according to Ibbotson Associates. That means $1,000 invested in 1926 ballooned to more than $8 million over that span. Growth stocks, meanwhile, returned only about 9.2% annually during those 76 years -- turning $1,000 invested in 1926 into roughly $800,000, or one-tenth that amount you got from value stocks.
Over a shorter period of time, the difference is still big. If you invest in value stocks for 20 years and earn the historical return, your $10,000 investment grows to $107,000. That same $10,000 invested in growth stocks increases to only $58,000.
Buy at the right time
You have to know what a company should be worth before you can be sure you're buying its stock at a good price. Some of today's greatest companies are tremendously overvalued -- Google
Admittedly, finding value stocks by dissecting financial statements takes time and expertise I don't have. But I've found a solution: Philip Durell, the lead analyst for the Motley FoolInside Value newsletter. Philip gives me great investment picks, and he shows me how he found them. Even better: His picks are beating the market.
Two top value picks
Philip is offering a free 30-day trial to Inside Value. Click here to give the newsletter a try. This way, you can check out his picks and find out if Inside Value is a good fit -- without risking a penny. Either way, if you're serious about becoming a better investor and making money in this market, you owe it to yourself to learn more about value investing.
Fool contributor Tony Cornish is a huge fan of Inside Value, especially the discussion boards. He owns no shares of companies mentioned. The Motley Fool has a disclosure policy.