What are value stocks?
Value stocks are stocks of companies that are trading at a lower price relative to their fundamentals such as earnings, dividends, or sales, thus, making such companies attractive to value investors.
Value stocks are those types of stocks that trade at a lower price than what the company’s performance may indicate. Because, the price of the stock may not match the performance of the company, value investors attempt to capitalize on inefficiencies in the market. They look for inefficiencies in the market that make the stocks of truly valuable companies to be priced at less than what they’re worth. The common features seen among value stocks are that they tend to have a high dividend yield, a low price-to-earnings ratio (P/E ratio), and a low price-to-book ratio (P/B).
These stocks can generally be compared with growth stocks. Compared to value stocks, growth stocks are stocks of companies with strong anticipated potential for growth. However, a balanced diversified portfolio would hold both growth and value stocks. This is referred to by investment managers as a blend fund. A blend fund is a kind of equity mutual fund that has a mix of both growth and value stocks.
An investment strategy that involves buying stocks that seem to be trading less than the company’s intrinsic or book value is known as value investing. People with this investment strategy are referred to as value investors. What they do is pick out stocks that they believe the stock market is underestimating.
They are of the opinion that the market overreacts to good and bad news, hence, causing changes in the stock price which doesn’t correspond to the long-term fundamentals of a company. The overreaction of the market gives these investors an opportunity to make a profit by buying stocks put on sale at discounted prices. There are so many known value investors such as Warren Buffet, Benjamin Graham, Charlie Munger, Seth Klarman, Christopher Browne, and David Dodd.
What stocks are value stocks?
Stocks that are considered value stocks are companies with price-to-earnings or price-to-book ratios that are lower than the broader market. The stocks of companies that are traded below their peers in the industry are considered value stocks. This means the stock has an equity price that is lower than the stock prices of other companies in the same industry. These stocks may sit within a sector that trades their stocks at a discount to the broader market. In addition, value stocks are companies that grow their earnings and revenue at a slower rate compared to the market.
Value stocks will have a bargain price because investors see the company as unfavorable in the marketplace. Negative publicity due to legal problems or unsatisfactory earnings reports can indicate a value stock. This is because the market tends to view the long-term prospects of such companies negatively. This means that value stocks can probably come from mature companies with stable dividend issuance that is for the time being experiencing adverse events.
How to find value stocks
The essence of value investing is to look out for companies that are trading their stocks at a discount to their intrinsic value with the hope that over time, they will probably outperform the overall stock market. Finding such stocks that are undervalued may not be that easy. Value investing comes with hard work and lots of research. Hence, it is advisable to not invest in a company that you do not understand. Do your research and be sure that you understand the management team and principles of the company. Enquire to know what the long-term plans for new products and services in the company are and be sure that these goals will position the company for continued success.
Also, check for the relative performance of the company by assessing if the share price of the company lags the performance of competitors over time. Sometimes, discrete events in a company’s history such as a PR disaster or missed guidance that are not related to the company’s fundamentals can make the share price of the company lower. Hence, if the market drives the company’s share price too low, the shares could enter the value stock category.
You need to research to be able to deploy fundamental analysis in finding value stocks and learning their intrinsic value. The following are the best metrics to keep in your tool kits when carrying out fundamental analysis for value stocks:
- Price to earnings ratio (P/E)
- PEG ratio
- Price to book value ratio (P/B)
- Price to sales ratio (P/S)
- High free cash flow
- High dividend yield
Find the price-to-earnings ratio (P/E)
The fundamental analysis starts with looking at the P/E ratio. This ratio is the best-known metric used for stock valuation. It is very useful when comparing the valuations of companies in the same industry. The P/E ratio is calculated by dividing the current stock price of the company by its earnings per share. The stock price tells how much people are willing to purchase one share of the company while the P/E ratio suggests if the price accurately reflects the company’s earnings potential or not. Value stocks tend to have low P/E ratios as a low price-to-earnings ratio suggests an undervalued stock.
Calculate the PEG ratio
This ratio means a price-to-earnings-to-growth ratio which is similar to the P/E ratio but focuses on determining the relative trade-off between a stock price, the earnings generated per share (EPS), and the company’s expected growth. This valuation metric is calculated by dividing the price-to-earnings (P/E) ratio of stock by the growth rate of its earnings for a specified period of time. It is better to use the PEG ratio when comparing companies with different growth rates. Investors are always on the lookout for stocks with a good PEG ratio of 1.0 or lower. Such a PEG range suggests that the stock is fairly priced or even undervalued. A PEG ratio above 1.0 suggests that the stock may be overvalued.
Find the price-to-book value ratio (P/B)
The book value is thought of as what will be left theoretically if a company stops operation and sells all its assets. The P/B ratio is the concept of calculating the share price of the company as a multiple of its book value. This will help identify undervalued opportunities. The ratio is used as a metric for investors to assess whether a stock is valued properly. Hence, it gives an idea of whether the investor is paying too much for what will be left if the company went bankrupt.
The P/B ratio is calculated by dividing the company’s market capitalization by its book value of equity or by dividing the current share price by its book value per share. People who are into value investing specifically look for opportunities to buy stocks that are trading less than their book value.
Evaluate the price-to-sales ratio
The P/S ratio is calculated by dividing the market capitalization of the company by its total sales or revenue over the past 12 months. Companies with a low price-to-sales ratio tend to be more attractive to investors. They can use the price-to-sales ratio to know whether the stock is overvalued or undervalued, especially when the company is yet to earn a profit. Now, if the price-to-sales ratio is lower than the companies compared to in the same industry that is profitable, it may indicate a good investment. Investors may consider buying the stock due to the low valuation. However, when evaluating if a stock is valued properly, the P/S ratio has to be used with other market prospect ratios and financial metrics/ratios.
Scout for companies with high free cash flow
Value investors also check if the company has a high free cash flow. The amount of cash left after the company has taken care of capital expenditure and expenses for operational activities is known as the free cash flow. A good value stock candidate may be a company with plenty of free cash flow and low relative share prices to its competitors, probably due to weak earnings reports.
Search for companies with a high dividend yield
The share price of a company could be undervalued relative to its dividend if the dividend yield of the company exceeds its competitors. Nevertheless, this could also mean that the company is in a financial crisis or paying unsustainable dividends, so one has to be careful.
What are value stocks examples?
The examples of value stocks in the stock market will include companies that are probably trading their stocks at a discount to their intrinsic value.
Examples of value stocks to buy
- M&T Bank Corp. (MTB)
- Lam Research Corp. (LRCX)
- Laboratory Corp. of America (LH)
- Hartford Financial Services Group (HIG)
- United Rentals (URI)
- Best Buy Co. (BBY)
- Seagate Technology Holdings (STX)
- Warner Bros Discovery (WBD)
According to an article, ‘The Best Value Stocks Of 2022’ on www.forbes.com, bank of America analysts recently listed the above examples as the eight top value stock picks with the most upside as of May 19, 2022. These stocks listed are sourced from industry analysts and may be among the best value stocks to buy right now. However, they may not fit perfectly into every investor’s portfolio. Hence, before any investor decides to purchase any of these stocks, they should do plenty of research to be sure they align with their financial goals and risk tolerance. Here is a table showing these examples of value stocks and some of their fundamentals as stated in the article ‘The Best Value Stocks Of 2022‘.
|Current value stocks examples||Price/Earnings Ratio as of May 19, 2022||Price/Book Ratio as of May 19, 2022||Price/Sales Ratio as of May 19, 2022||Dividend yield as of July 22, 2022||The stock price as of July 22, 2022|
|1||M&T Bank Corp. (MTB)||13||1.9||3.7||2.84%||169.22 USD|
|2||Lam Research Corp. (LRCX)||16||11.8||4.3||1.26%||476.13 USD|
|3||Laboratory Corp. of America (LH)||11.4||2.1||1.5||1.16%||249.09 USD|
|4||Hartford Financial Services Group (HIG)||9.8||1.5||1.1||2.44%||63.06 USD|
|5||United Rentals (URI)||13.6||3.4||2.1||–||279.79 USD|
|6||Best Buy Co. (BBY)||8.67||6.3||0.4||4.50%||78.20 USD|
|7||Seagate Technology Holdings (STX)||10.8||44.4||1.6||3.35%||83.61 USD|
|8||Warner Bros Discovery (WBD)||9.1||3.7||1.0||–||14.39 USD|
Pros and cons of value stocks
There are advantages and disadvantages to value investing. Value stocks are a good choice for people with long-term investment goals. The goal of buying value stocks is to earn steady, reliable returns over a very long period of time and not for quick gain over the short term. Value stocks can turn profitable in the long run. However, for this to happen, the market has to alter its perception of the company. This is why value stocks are considered risker than growth stocks due to the skeptical attitude that the market has towards them. Hence, due to the underlying risk, value stocks are actually more likely to have a higher long-term return than growth stocks.
The major risk with value stocks is that they need some time to emerge from their underpriced position which may never materialize. Undervalued companies may decrease from their current value or may never get the chance to become appropriately valued. This is why it is good to diversify your value stock portfolio by buying shares of many different companies. This diversification strategy helps to offset losses and underperformance.Last Updated on July 27, 2022 by Nansel Nanzip Bongdap
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