Everybody loves discounts!
Why?
Those are special times when your favourite brands/vendors sell premium goods at a bargain (discount). However, because you got them at a reduced price doesn’t tamper with their quality. You get to enjoy the same top-notch quality, comfort and style, but at a more affordable cost.
Value stocks work in a similar pattern.
When you invest in value stocks, you’re essentially looking out for opportunities to purchase shares of well-established companies at a lower price than their essential value.
Investors who buy these value stocks believe that, over time, the market will recognize the true value of the company and the stock price will increase accordingly leading to profit for them.
Now, let’s define Value stocks holistically.
What is a Value Stock?
This is a stock that trades below its intrinsic value thereby making it a good asset to invest in because of its prospect. Investors following a value investing strategy usually look for stocks with low price-to-earnings (P/E) ratios, low price-to-book (P/B) ratios, and stable fundamentals. This is because they believe that these stocks have the potential for long-term capital appreciation as the market corrects the perceived undervaluation.
How to Select and Invest in Value Stocks
You’ll be able to identify value stocks because they’ll be traded at a bargain due to unfavourable conditions the company is facing at that time. For more clarity, here are several methods to determine whether a stock is undervalued.
1. Low Price-to-Earnings
Price-to-earning (P/E) is calculated by dividing the stock price by the company’s earnings by share (EPS). A lower P/E indicates that the stock is undervalued and likely to be a value stock i.e. it has a future potential of growing in profit.
Let’s use an example to explain better:
Company ABC has a stock trading at $40 per share and earns $4 per share in profit annually. The Price-to-earning ( P/E) is calculated by dividing the stock price by earnings per share (EPS): $40÷$4= 10.
A P/E of 10 shows that investors are willing to pay $10 for every $1 of earnings. Now, if similar companies in the industry have an average P/E of 15, then, company ABC might be considered undervalued because it has a lower P/E compared to the industry average. Therefore, it can be considered as a value stock.
2. Analyse the Price-to-Book
This is calculated by comparing a company’s stock price to its book value (total assets minus any liabilities) per share.
Here’s an example:
If Company XYZ’s stock is trading at $50/share and its book value is $40/share, the P/B would be the stock price divided by the book value per share: $50/$40 = 1.25.
A P/B ratio of 1.25 indicates that the stock is trading at a 25% premium to its book value. So, if other companies within the same sector have an average P/B of 1.75, then Company XYZ may be considered undervalued—as it has a lower P/B and therefore could be a value stock.
3. Dividend Yield
Value stocks could also be indicated by a high dividend yield. A company’s stock could be undervalued and still offer dividends especially when the dividend yield is consistent and higher than the industry’s average.
4. Strong Fundamentals
The history of a company’s financial health is also a factor to consider. If the company is currently undervalued but has a history of great revenue growth, earnings growth and low debt level, it’s a strong indication of a value stock.
5. Industry Comparison
Another insight to consider is the company’s stock position within the industry and the broader market. You can identify a value stock when it’s trading at a lower valuation compared to its industry peers or market as a whole.
6. Market Capitalisation
Because smaller companies usually escape the market’s attention, it’s an opportunity for value investors to invest in them before they gain the spotlight’s attention.
Read: How to Build a Diversified Portfolio for Long-Term Success
Why are Some Stocks Undervalued?
Stocks can be undervalued depending on different reasons. It could be the market conditions, unfavourable news, poor financial performance, recession, the economy or even investors’ mood.
Regardless of the reasons, investing in value stock in the long run can be potentially profitable as the market situation is dynamic and a once undervalued stock can become valuable.
Why Should I Invest in Value Stocks?
Here are some top reasons to invest in value stocks:
- Lower risk: They often come with less risk compared to growth stocks. The more undervalued a stock is, the lower the stock price and the less you spend to buy it.
- Steady Income: Value stocks usually belong to established companies that pay dividends regularly. This means you not only benefit from potential stock price appreciation but also earn a steady income in the form of dividends.
- Historical Success: One of the greatest investors of all time, Warren Buffet is one of the top value investors today. Others include (Warren Buffet’s professor and mentor) Benjamin Graham, Christopher Browne, a student of Graham, David Dodd, Charlie Munger (Buffet’s business partner), and Seth Klarman. These top investors prove that investing in value stocks can result in long-term growth.
How to Profit from Value Stocks
Once you identify value stocks, the next thing you should do is invest them in a trading platform like Trove Finance. From this point upward, the key is to buy and hold for the long term. Value Investing is a strategy pattern of investing that requires a long-term view. So patience should be your best friend. Over time, if the stock is undervalued, the stock price is likely to rise.
Conclusion
Value stocks are sometimes a good opportunity to invest in established companies of your choice at prices below their intrinsic value. This is similar to enjoying premium goods at a discount. Characteristics of value stocks include low P/E and P/B ratios, strong fundamentals, and sometimes high dividend yields.
Therefore, analyzing these factors can help you identify undervalued stocks. While stocks may be undervalued for various reasons, value investing offers lower risk, steady income through dividends, and a history of success. The key to profiting is a long-term investment approach, requiring patience and a strategic perspective.
Hope you found this post helpful. Visit the trove finance website today to experience a simplified investment.
