Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 17

Value investing and valuing a business

Originating from the economist and investor Benjamin Graham, the philosophy of value investing has been a strategy employed by some of the most successful investors in history including Warren Buffet and David Dodd. This approach revolves around investing in stocks trading at a discount to their intrinsic value but there is always one critical question inherent in this investment philosophy; what valuation multiples do you use to identify the intrinsic value of a company?

Selecting valuation multiples

Unfortunately there is no single method of valuation and it is subjective whether an investor places more importance on current assets and earnings or on future cash flows and growth prospects. Over the years there have been opposing thoughts. Modern Portfolio Theory argues that due to the Efficient Market Hypothesis, all stocks trade at their fair value and it is impossible to identify undervalued shares. Yet it is widely agreed that value stocks have consistently outperformed growth stocks in the long term and some of the most successful investors have continued to outperform the market by identifying companies that are trading at a significant discount to their intrinsic value.

Keeping in mind that there are a range of multiples and valuation models that can be employed in value investing, there are some key factors that are often considered in valuing a business.

When we qualitatively analyse the quality of a business, the fundamental drivers of value include the company’s management team and their experience in the respective sector, the company’s strategy and plans in place for the company’s expansion. Translating this to quantitative drivers, return on equity and capital, debt to equity ratios and cost of capital come into play. A value investor should also take into consideration accounting policy differences which can skew profit multiples, and can lead to misleading valuations of companies in comparison to its sector. Depreciation, goodwill, provisions and deferred tax should be considered. As a result, a company’s cash flow is a good metric for valuation as it is free from accounting distortions and its EBITDA is a suitable measure to assess profitability.

The Price to Earnings (PE) Ratio is one of the most common multiples used by the retail investor to indicate if a share is over or undervalued but this can be misleading for a few reasons:

  • earnings are subject to different accounting policies
  • different capital structures will lead to a gearing effect on the earnings which will skew results for different companies
  • a low PE could be a sign of negative market sentiment towards the stock rather than a reflection of the stock being undervalued.

The Price to Book Value, which represents a company’s share price over its book value, is often used to value a business where value is generated through its tangible assets. This is where Return on Equity comes into play. Financial stocks, especially banks, are often valued using the Return on Equity ratio due to their high levels of leverage from deposits coupled with significant assets through loans. Return on Equity can reflect how efficiently a company utilises shareholders’ equity to produce profit, as well as how effective the company manages its debt and asset turnover. A company with a consistently increasing Return on Equity and a decreasing debt level is often a sign of an effectively-managed business.

After analysing these key valuation multiples, investors should gain an in-depth understanding of the company’s business model and its sector to make a more informed investment decision.

What to look for in listed companies

My golden rules for investing are:

  • Make informed and educated investment decisions
  • Know why you are buying shares in the company
  • Do not speculate
  • Invest only when there is an opportunity
  • Invest in quality companies with great future prospects
  • Understand the business before investing
  • Have an exit strategy
  • Have patience and discipline.

Value investing is a strategy used by some of the most renowned investors in history and is a proven approach that can help the medium to long term investor identify undervalued businesses. The market is dynamic and volatile and investors should have a clear strategy and direction before making any investment decision. An individual should invest in quality stocks that are trading below their intrinsic value with a target in mind.

 

Michael Kodari is Managing Director of Kodari Securities (KOSEC).

 

RELATED ARTICLES

Quality over quantity: a lesson of value

Don’t go swimming naked for a short term thrill

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.