What Are Value Stocks?

When looking for the finest investment techniques, you may have come across the term value investing. This method was developed in the 1920s by Benjamin Graham, an American investor, lecturer, and economist who is also known as the “Father of Value Investing.”

This investment strategy has been utilized by various big investors over the years, including Warren Buffet and Peter Lynch. Let’s delve more into how this method works!

 

What do we mean by value stocks?

A value stock is one whose current share price is less than its inherent value, for whatever reason. The market considers the stock’s fundamentals, such as earnings, P/E ratio, and book value, as less robust than its peers and hence prices it accordingly. Value stocks, as opposed to growth stocks, tend to be older, more established corporations with shares trading at discount rates.

Value investing is a method in which shareholders acquire a stock with the idea that it will rise in value over time as the market considers both the company’s general health and its prospects.

Interestingly, value equities have historically outperformed growth companies, in part because they typically pay dividends or cash payouts. It’s similar to a corporation rewarding investors.

What Determines a Stock’s Value?

The value of a stock is set by the simple laws of supply and demand: the quantity of accessible shares and the demand for them. Value investors seek imperfections in the market that cause highly valuable companies to be valued below their true worth. Fundamentals such as a stock’s price-to-earnings ratio, which compares a stock’s current price to its earnings per share, are one way to assess its worth. A value company has a lower P/E ratio than the broader market, which is a desirable thing. In general, the lower the P/E ratio, the better, because it suggests you are paying less for every dollar of earnings.

Why Do Value Stocks Usually Offer Dividends?

Dividends, or monthly cash payments to shareholders from the company’s profits, are common in value stocks. Dividend payments are normally made regularly, however, special pay-outs can be made at any time. Why would a corporation pay out a dividend? The argument is that because these companies are further along in their business cycle, they simply do not need to reinvest all of their income.

What do we mean by value premium?

The value premium refers to the higher historical returns that value companies can deliver over growth stocks. Some of it is due to dividend payments, as mature corporations motivate investors to repay them for the risk they take by purchasing shares. Furthermore, paying a dividend is one way for a firm to appeal to investors even if it is experiencing slow earnings growth, which would affect its share price.

Top Fundamental Factors for Selecting Value-Investing Stocks

Graham identified seven parameters to choose ‘value’ companies in his book, ‘The Intelligent Investor.

1. Quality Rating 

He suggests choosing companies with average or superior ratings. It is not necessary to select the highest-rated companies. Those simply have to be better than the majority. The Standard & Poor’s (S&P) rating system, for example, spans from D to A+. Companies with an S&P Earnings and Dividend Rating of B or higher will work.

2. Debt to Current Asset Ratio 

Debt is an important metric to consider when investing in a firm. Graham advises investors to look for companies with a total debt-to-current ratio of less than 1.10.

3. Current Ratio

Divide current assets by current liabilities to get the current ratio. According to Graham, a ratio greater than 1.50 indicates investing comfort.

4. Positive Earnings Per Share Growth

Examine the earnings per share for the previous five years. There should be no earnings shortfall in any of the years. Choose organisations that have a track record of continuous earnings growth. Avoid companies with erratic earnings growth.

5. P/E Ratio 

P represents price and E stands for earnings per share in the PE ratio. The PE ratio indicates how much the market is willing to pay for a stock based on its earnings per share.

Graham recommends investing in companies with P/E ratios of 9.0 or lower. This will aid you in your deal-searching.

6. Price to Book Value

Price to book value, or P/BV, is an essential financial statistic. It is computed by dividing the current price by the most recent book value per share of a company. A ratio of less than 1.20 is considered safe.

7. Dividends 

When investing in a value stock, the wait for a price increase might be long and frustrating. Having stated that your value option should be a dividend-paying stock. Price increases may not occur for several years, but you will receive dividends.

Advantages of Value Investing

• You get to invest in quality firms at lower levels, increasing your chances of landing multi-baggers.
• Value investing is based on rigorous fundamental examination. It leaves no room for conjecture.

Disadvantages of Value Investing

• Investing in value is difficult. Any mistake and one may fall into a ‘value’ trap, which has lower valuations but no possibility for growth.
• Value investment necessitates patience. The wait might be measured in years. To stay invested in value equities, one must have a strong conviction.
• Value investing may not provide you with enough diversification. It is difficult to locate bargain buys in each industry required for diversification.

Value investing is ideal for investors with a medium-risk tolerance. When they allocate their resources to stocks with high intrinsic value, their investment might expand exponentially over time. However, in order to successfully utilise this technique, the right stocks must be selected. Furthermore, keep in mind that this is a long-term investing approach. So, even during periods of short-term price volatility, you must stay unafraid.