What are Value Stocks and How to Find Value Stocks to Invest in?7 min read
What are Value Stocks?
In the simplest terms, a value stock is a strategy where investors look forward to buying stocks that are on sale, specifically at a discount or lower than their intrinsic value. Value investors want to buy stocks for less than what they are worth. The equivalent of a cheaper or discounted stock in the stock market is when the shares are undervalued. Value investors hope to profit from the stocks they perceive to be the ones deeply discounted. Value stocks are the shares of a company that appears to trade at lower prices relative to its fundamentals like dividends, earnings, and sales.
With value stocks, the company’s stock price can change even when the company’s value remains the same. For instance, stocks like TVs go through varied periods of high and low demand leading to price fluctuations, but that does not change what you are getting for your money. Just as savvy shoppers say, it makes no sense to pay full prices for TVs since they go on sale several times a year, savvy value investors believe that stocks work the same way. If I have to make it clearer to you, would you not like to buy $100 bills at $80, and you would do it frequently, just to make more out of it, if you had the chance, right? The same applies to value stocks.
How to Find the Best Value Stocks?
The core point of value investing is identifying companies trading at a discount to their intrinsic value and with an idea that they would outperform the overall stock market over time. But to be very honest, we know, finding stocks that sell less than their worth is easier than done.
So here are the tips you need to keep handy in your toolkit:
P/E ratio: This is the top stock-valuation metric. The price-to-earnings, or P/E, can be a useful tool to compare valuations of companies in the same industry. To calculate it, simply divide the company’s stock price by its last 12 months of earnings.
PEG ratio: It is quite similar to the first metric, but it adjusts to the level playing field between companies that might be growing at slightly different rates. By dividing a company’s P/E ratio by its annualized earnings growth rate, you get an easier comparison ratio. It is like apples to apples, even between different businesses.
Price-to-book (P/B) ratio: Think of the book value as that is what would theoretically be left if a company has ceased operations and sold all its assets. Calculating the company’s share price as a multiple of its book value and can help identify undervalued opportunities. Many value investors specifically look out for opportunities to buy stocks trading for less than their actual book value.
Did you Know what Makes up a Great Value Stock?
It has an inexpensive valuation compared to the value of its assets of the key financial metrics like revenue, earnings, and cash flow. The best value stocks are the ones that have attractive characteristics which appeal to investors, no doubt.
- A well-established business with a long history of success.
- A consistent profit cycle.
- A stable revenue stream with high growth but also without any typical big sales contractions.
- Dividend payments, though paying a dividend isn’t a requirement to qualify to a value stock.
For instance, Viatris (VTRS), Lincoln National Corp. (LNC), NRG Energy (NRG), AbbVie (ABBV), PulteGroup (PHM), Bristol, Myers Squibb Co. (BMY), and Synchrony Financial (SYF) are some value stocks that have outperformed growth stocks and have seen a surge of value investors diving towards them. Investors and analysts are drawing comparisons between the market’s climate today and the bubble of the late 1990s. In the early 2000s, value stocks in the financial, energy, and real estate markets left even many of the high-growth tech stocks in the dust.
Strategies that Help you Become a Better Value Investor
Do Not Confuse Price with Value – Keep in mind, price is what you pay for something, but the value, on the other hand, is what it is worth. It is a ‘must note’ for value investors, because frequently there are a lot of good reasons for why a stock is discounted.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffet
Value investors will dig deep into a company’s financials, whether the low stock price is an opportunity or a mere reflection of the intrinsic value.
Count on Fundamental Analysis – This is more than an option. Every investor needs to know how to utilize fundamental analysis to perform diligence. A successful value investor always looks at fundamental analyses like price-to-earnings or price-to-book ratio.
Know what you Own – “Do No Harm,” is an axiom of value investors. The guiding line for a value investor is to not lose money. This strategy is to help preserve capital by looking for a stock that has an appropriate margin of safety. It means looking for a stock selling below its intrinsic value and trading significantly, which gives it maximum value.
Value Stocks are the Ones that Frequently Pay Dividend – Promising value stock candidates most frequently tend to be mature companies. When a certain company has reached a specific stage in its life cycle, there is a lesser need to plow money. It is focal where many companies choose to pass along some of the profits to the shareholders by a way of dividends.
Still, the absence of a dividend does not mean that a stock is not a value stock, but it may have a higher bar for value investors to climb.
What are Value Stock Traps?
You need to know what value traps are. There are times when traps pop out in certain situations for value investors. And they need to look out for it.
- Stocks in industries such as manufacturing, construction, or in whole cyclical industries are ones that often witness their earnings rise substantially during booms, only to see that much of them disappear when the industry conditions cool off. When investors see a possible bust coming for certain stocks, their valuation turns to look very inexpensive compared to their recent earnings- but much less so once earnings fall during the weak part of the business cycle.
- Stocks emphasized on intellectual property are more prone to become value traps. For example, if a drug business has a high selling treatment but loses patent protection for that in the near future, most of the profit can actually disappear fast. The same follows for a tech company that is the first mover in a new industry but cannot protect itself against the competition.
For you to not fall prey to these value traps, remember that a company’s future is more important than its past while valuing a stock. When you focus more on a company’s prospects for sales and earnings growth in the months and years to come, you will be more likely to find true value stocks.
Is Value Investing the Right Thing for You?
Is your primary investing goal to keep your risk of permanent losses to an absolute minimum while increasing your odds of generating positive returns? Then you are most probably a value investor at heart.
Those who prefer to follow the trending companies of the market often find value investing quite boring since the growth at value companies tend to be tepid at best.
Being a value investor means eliminating far more stocks than you uncover. It can be a frustrating type of investment in a bull market, as many stocks that you initially cross off would rise in price in a bull market.
Value investing, of course, requires a long-term mindset. Though value investing takes time to follow, the time and effort spent are quite worth it.
Value Investors Who Made it Big
Benjamin Graham – He is also regarded as the father of value investing. He became a partner at a Wall Street firm just after six years of his graduation. His aim at a careful selection of stocks for portfolio diversification paved the path to fundamental analysis and to determine a company’s intrinsic value.
Warren Buffet – He bought his first stock at the age of 11, can you believe it? And in his 80s, he is still at it. Now he buys companies outright for his company (Berkshire Hathaway). His focus on the stock market opening every morning sets him aside from the rest of the crowd. He runs both a sprint and a marathon. Buffett and his team manage over $200 billion in stocks in public companies right now. His company is a longtime shareholder of stalwarts like American Express Company, Coca-Cola Co, and Wells Fargo & Co.
The Final Word on Value Investing
Rather than blindly following a herd, or chasing a stock on its route to the highway, a value investor questions why. That is what value investing is all about. Being a value investor requires patience, stock identification for stocks trading below their intrinsic value, and it can take quite some time for that stock’s price to rise. Being able to buy and hold these stocks is a crucial part of value investing.
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