Value Stocks: Understanding It and How to Invest

Value stocks

Investing in some of the best value stocks means to capitalize on inefficiencies in the market.  As you would do security trading at an under-valued price than what the company’s performance may otherwise indicate. Since the price of the underlying equity may not match the company’s performance, investors like to play around with a bargain price. Many investors believe that the market over reacts to any news, resulting in stock price changes which do not accurately depict the strength of the underlying fundamentals of the company. Hence, such stocks that are currently trading at a price below the intrinsic value of their company are known as value stocks.

Value Stocks: How to Invest and Risks

What is a Value Stock?

A value stock is generally traded at an equity price lower than the stock price of certain companies within the industry. The dividends, earnings, or sales are lowered to make it more appealing to value investors. Investors use this to calculate the value of the stock of a company:

Price-to-book ratio (P/B ratio)

It’s calculated by dividing the company’s stock price by its book value per share. Book value is the total assets minus any liabilities. Low P/B ratios can be indicative of undervalued stocks, and can be useful when finding a value stock.

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Price-to-earnings ratio (P/E ratio)

Calculated by dividing the company’s stock price by its earnings per share. P/E ratio helps to determine the relationship between the stock price in the market and its actual earnings as per books. Low P/E ratios indicate that the stocks are undervalued and thus have a chance of future increment in share price.

Price-to-sales ratio (P/S ratio)

Calculated by dividing the market capitalization by the company’s total sales or revenue. Market capitalization means the total outstanding shares multiplied by the share price per share in the market. A low P/S ratio indicates a good buy as the stock is undervalued.

How to spot Value Stocks:

A value stock will have a bargain-price as investors see the company as unfavorable in the marketplace. Or VS can be within a sector that trades at a discount to the broader market. Negative publicity from low earnings reports or legal problems also indicates a value stock as the market will negatively view the company’s long-term value.

A value stock will most likely come from a mature company with a stable dividend issuance that is temporarily experiencing adverse events. But companies that have recently issued equities have high-value potential as many investors may be unaware of the entity.

According to Fool.com, the 3 best value stocks to invest in July 2020 are Walt Disney (NYSE:DIS), as the diversified entertainment company is trading at an attractive discount in lieu of the coronavirus pandemic, Altria (NYSE:MO), as the tobacco giant has raised its dividend for five decades in a row and lastly, Walmart (NYSE:WMT), which is poised to benefit from surging growth in its e-commerce business.

Risk and return of Value Stocks:

For all their potential pluses, value stocks are considered riskier than growth stocks because of the skeptical attitude the market has toward them. Investing in value stocks or value investing is an approach based on the premise that the market will eventually take cognizance of the true potential of these stocks and hence the price will regain pace resulting in good profits.

For a value stock to turn profitable, the market must alter the company perception which is riskier than a growth entity developing. VS is thus more likely to have a higher long-term return than a growth stock because of the underlying risk. The risk of investing in a value stock is that it’s emergence from its undervalued position may never materialize.

Example of Value Stocks:

In June 2019 these center banks represented value stocks:

  • JPMorgan Chase & Co. (JPM), and Citigroup Inc. (C) trade at a significant discount to the market based on earnings.
  • Citigroup has a P/E ratio of 9.67 compared to 19.12 for the average S&P 500 company.

Importance of valuation of stocks:

In an ideal situation, the share price in the stock should be equal to its intrinsic value. In the long run, the price of stock will be approximately equal to its value, but the same doesn’t exist in the short run for various reasons. The reasons could be macroeconomic disturbances, or the cyclical nature of the sector that the business belongs to. The value investors expect the market to eventually recognize the mispricing and correct it. This is why experienced investors participate by going for fundamentally strong stocks, trading at a low price. Without this reference point, it will be impossible to execute the “buy low, sell high” investment strategy.

In conclusion, while looking for the best value stocks to buy, investors must rely on their own research, financial goals and risk appetite and treat the “best value stocks for the year” lists released by the media with discretion. Analyse the type of industry in which the company is and its future prospects as well.

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