Buying shares of stock is one of the most common ways to invest. Shares represent partial ownership of a business. As other investors are willing to pay more to own the shares, based on the company's value or future expected value rising, current shareholders can sell and profit. Value-based investment models can provide a framework for buying shares in rational and profitable ways.
Value-based investment models state that investors should purchase shares that are undervalued by the market. As investors buy and sell shares of stock, they impact prices based on the principle of supply and demand. This means that at any given time, some shares cost more than they are worth, while others are undervalued. Value-based investing can include buying shares in businesses from all sectors of the economy, including large corporations and small businesses.
While any investment theory that focuses on buying undervalued shares can be called a value-based investment model, the original model comes from noted investor Benjamin Graham. Graham's model, which has influenced many investors and financiers, including Warren Buffet, is based on using the financial data companies release to identify undervalued shares. While Graham's value-based model dates from the 1930s and 1940s, investors around the world have been making value-based decisions for much longer.
A value-based investment model can use one of several techniques to identify shares to buy. In some cases, investors identify businesses that are undervalued and purchase as many shares as they can afford. They can use their votes and influence to push the company toward reaching its full potential and, in the process, increasing share value. In other cases, an investor buys shares of stock that have recently fallen in value in the hope that the sell-off pushed those shares to prices below their true value.
Pros and Cons
The value-based investment model for choosing shares works in conjunction with other investment models, which means investors can use it alongside other strategies. This is one of its key benefits. For example, an investor can use a diversification approach to select shares from unrelated businesses, employing the value-based model to select specific shares in different categories. The value-based model requires planning and research. However, it provides a high potential for gains and limited risk because investors only buy stock at its perceived lowest values. This places a reasonable cap on possible losses.
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