What exactly is value investing? Is it the same as 'buying cheap stocks'?

Simply put, value investing is 'buying quality assets at prices below their intrinsic value.' Intrinsic value is the true value estimated based on a company's fundamentals (such as cash flow, earnings, assets)^[1]. If a stock's market price is significantly below this value, there is a 'discount,' and value investors will pay attention. You can think of intrinsic value as the actual quality of a product, and the market price as its price tag. Value investing is about finding products whose price tags are lower than their actual quality, and then buying them.

But note, a low P/E or low P/B is just the starting point for screening, not the true value. If a company's fundamentals are deteriorating, no matter how low the stock price is, it could be a 'value trap'—it looks cheap but is actually becoming less valuable^[1]. For example, a company whose products are outdated and market share is shrinking, leading to declining earnings year after year, the stock price may have fallen to very low levels, but it could still continue to fall. So, value investing is not just buying cheap stuff, but buying 'good things that are undervalued.' You need to act like a detective, researching the company's financial statements, industry position, and competitive advantages to confirm whether it is truly mispriced by the market, or whether its fundamentals have already deteriorated.

What does Buffett mean by 'margin of safety'? Why is it so important?

'Margin of safety' is the cornerstone of value investing, proposed by Graham in his 1934 book 'Security Analysis'^[2]. It refers to the difference between intrinsic value and market price. For example: you estimate a stock's intrinsic value at 100 yuan, but the market only sells it for 70 yuan, so the margin of safety is 30%. This 30% difference is your 'cushion.'

Why leave this difference? Because valuation itself has errors, and the market may continue to fall. Margin of safety is like buying insurance, giving you room for mistakes. For instance, your estimate of intrinsic value might be overly optimistic, or market sentiment could cause the stock price to fall further; margin of safety helps reduce your losses. Graham considered this the most important principle in investing^[2]. Buffett has also always emphasized that the first rule of investing is 'don't lose money,' and the second is 'remember the first rule,' and margin of safety is key to achieving this. Investing without a margin of safety is like driving on the edge of a cliff; if the road conditions deviate slightly, you could fall into the abyss.

Why did Buffett shift from 'cigar butt' investing to buying quality companies?

Buffett's teacher Graham liked 'cigar butt' investing—looking for 'junk' companies whose stock prices were far below net asset value, to get one last free puff. This strategy worked well in Graham's era because information was opaque, and many companies were indeed severely undervalued. But Buffett found in practice that such companies often remained in long-term distress, with limited returns. For example, you might buy a company on the verge of bankruptcy at a low price, and although the liquidation value of assets is higher than the stock price, the company's poor operations might slowly erode the assets, and ultimately your returns may not be satisfactory.

In his 1989 letter to shareholders, he wrote: 'It's far better to buy a wonderful company at a fair price than a fair company at a cheap price'^[3]. This shift marked Buffett's upgrade from 'buying cheap' to 'buying good companies.' He later placed more emphasis on a company's 'economic moat'—that is, durable competitive advantages such as brand, patents, and cost advantages, like Coca-Cola and GEICO^[4]. So, value investing is not about clinging to low valuations, but about dynamic evolution. You need to pay attention to whether the price is reasonable and whether the company's quality is excellent.

What is a 'moat'? Why does Buffett value it so highly?

'Moat' is Buffett's metaphor for durable competitive advantage. He looks for 'economic castles' protected by wide moats^[4]. Imagine a castle surrounded by a wide and deep moat; enemies find it hard to attack. A company's moat is the barrier that allows it to fend off competitors. Under capitalism, competitors constantly attack any high-return castle, so the moat must be wide and durable. Examples include being the lowest-cost producer in the industry (GEICO, Costco) or having a powerful global brand (Coca-Cola, Gillette)^[4].

The value of a moat is that it allows a company to maintain high profitability over the long term, thereby supporting the growth of intrinsic value. A company without a moat, even if cheap now, may have its profits eroded by competition, and value realization may be indefinitely delayed. For instance, a restaurant might have good food, but imitators quickly appear, and profits get divided. So, the moat is an important criterion for value investors to judge 'good companies.' You can observe which companies have moats in daily life: for example, if you habitually use a certain brand of toothpaste and buy it even if it's a bit more expensive, that's a brand moat.

What is a 'circle of competence'? How can ordinary investors define their own?

Buffett proposed the concept of 'circle of competence': you don't need to understand all companies, only those within your circle. He said: 'The size of the circle is not very important; knowing its boundaries, however, is vital'^[5]. For example, if you work in the healthcare industry, you might know more about pharmaceutical companies; that's your circle of competence. Your circle of competence is like your knowledge boundary; inside are areas you are familiar with and can understand business models and competitive advantages, while outside are areas you don't understand and are prone to mistakes.

Ordinary investors can start with industries, products, or services they are familiar with. For example, if you use a certain app every day, you can research its business model. For industries you don't understand, even if others are making a fortune, don't touch them. Staying within your circle of competence helps avoid pitfalls from ignorance. For instance, if you know nothing about tech companies, don't blindly buy just because others say AI has prospects, because you can't judge their true value. You can start with industries you work in, brands you consume daily, or even companies related to your hobbies, and gradually expand your circle.

What is the difference between value investing and growth investing? Which is more suitable for ordinary people?

Value investing focuses on companies trading at a discount to intrinsic value, often found in sectors like financials and energy with low P/E ratios and high dividends; growth investing focuses on companies with rapid revenue/earnings growth, often found in sectors like technology and communication services with high P/E ratios and high volatility^[6]. Growth stocks offer higher potential returns but also higher volatility; if growth disappoints, the stock price can plummet. Value stocks rely more on dividends and valuation recovery, and are relatively stable^[6]. For example, a growth stock is like a young racehorse that can run fast but might suddenly stumble; a value stock is like a steady old ox that, while slow, takes steady steps.

There is no absolute 'better'; it depends on your risk tolerance and investment horizon. Value investing requires more patience, waiting for the market to correct errors; growth investing requires enduring greater volatility. For ordinary retail investors, value investing may be more friendly because its logic is closer to 'buying good things at reasonable prices,' and dividends provide a buffer. To learn more about the differences, check out our article Growth vs. Value Stocks: Differences and Representative Companies Explained.

How long do you need to hold in value investing? Why is patience required?

Value investing is not short-term trading; market sentiment may take years to turn around for unpopular stocks^[1]. Graham proposed the 'Mr. Market' metaphor—imagine the market as an emotionally unstable partner who sometimes is ecstatic and quotes high prices, and sometimes is depressed and quotes low prices; this metaphor was later long cited and popularized by Buffett^[7]. Value investors should take advantage of Mr. Market's moods, not be led by them. For example, when Mr. Market is depressed, he quotes low prices, and you can buy; when he is ecstatic, he quotes high prices, and you can sell. But Mr. Market's mood changes can be slow, so you need patience.

Patiently waiting for value to be realized is the core of value investing. For example, Berkshire Hathaway, under Buffett's management since 1964 through the end of 2024, achieved an annualized return of about 19.9%, while the S&P 500 index returned about 10.4% annually over the same period^[8]. Behind this is the power of long-term compounding. Compounding is like rolling a snowball; the longer the time, the bigger the snowball. So, value investing suits investors with a long-term perspective who are not in a hurry. If you expect to get rich overnight, value investing may not be for you; but if you are willing to trade time for space, it may bring you substantial returns.