One of the basic rule to value investing is to determine the "value" of the company.  Then only buy shares if there is a "margin of safety" with the price per share. 

To get started with value investing it is important to know exactly what is meant by the word "value." When Ben Graham, the father of value investing, documented his approach back in the 1930s he perceived the value of a business to be simply the total value of the assets of the company. Back in the 20s, 30s and 40s it was possible to find stocks that were selling far below their actual value. To find a stock worth buying Ben Graham could find stocks where:

(total number of shares) * (price per share) < value of all assets owned by the company

In theory this means that if someone bought all the shares and then dissolved the company, they'd walk away with a profit.

This simplistic version of value investing simply doesn't work anymore. It's not that it would be a bad idea to buy stocks where the above formula is true, but the market doesn't present these opportunities anymore. In the 20s and 30s Ben Graham could routinely find stocks selling at 40 cents on the dollar.

Ben Graham taught his approach to investing at Columbia University. Many of his students paid their way through on what they learned in his class. One of his students was Warren Buffett.

Warren Buffett continued to expand on the work done by Ben Graham. In particular he was able to consider the intrinsic value of a business. A business is more than just the sum of its assets. The value of a business should also reflect the future earning potential of the business, the quality of management and brand recognition and loyalty.

The basic rule to value investing is to determine the "value" of the company, and then only buy shares if there is a "margin of safety" with the price per share. The margin of safety is how much below value the price is. Here's a basic example:

Let's say that we have determined company A to be valued at $1 billion. There are 100 million shares and the current price on the stock exchange is $7.00. The value per share is $10 ($1billion/100million). The margin of safety is $3. If the determined value of $1 billion is accurate then we'd expect the market to correct itself and properly value the business.

A larger margin of safety reduces the risk. If there was an error in the calculation or the market takes a long time to correct then at least there's a build in flexibility to handle those situations.

While the basis for determining the margin of safety is nice and simple to understand. The calculation of "value" is really the heart of the problem. If value is more abstract than just looking up the book value of a company then how can ordinary investors look at a complicated company like IBM and determine how much it's worth?

Here's how to start: Start with the book value then add the forecasted cash flow. If anything is happening in the company with regard to mergers and acquisitions then take those into account. Look at earnings and growth of earnings (if the company is on the way down then it may be currently priced at a predicted lower future value). Finally, try to quantify the value of the brand, intellectual property, and all other intangibles that make the business unique.

Do this sort of analysis a few times to get a feel for the numbers involved and where to locate them. With practice a perspective of what is a good deal should become apparent.

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