An Introduction to Value Stock Investing: A Time-Tested Formula for Investing
To start, there’s the concept of what is “value” when it comes to investing in general, then there are specifics in terms of value stock investing. Value is the notion that the price of a thing is distinguishable from its worth. In the case of common stocks, prices ought to reflect the value of the corporations they represent, but we observe that this is not always the case. Stocks can often have a life of their own trading wildly under the influence of many outside events such as prognostications about the economic cycle, interest rates, the money supply, rumors, Federal Reserve policy and government affairs. We think wild deviations from an estimate of a stock’s value create opportunities for patient investors.
Specifics on Value Stocks
A Value stock is a share of a company that trades for less than its fundamental value. In its most basic form, the fundamental value can be estimated by comparing the stock to a peer group, relative to its own history or both. Common measures of Value can include the price-to-earnings ratio, book value to market value ratios or price-to-sales ratios. Value can include a stock’s price in relation to past or estimated future earnings or sales, as well as its accounting book value. Companies considered to be Value stocks tend to have characteristics like steadier earnings streams and higher dividend payments compared to growth stocks.
For their academic research, Professors Eugene F. Fama and Kenneth R. French defined Value stocks as those that have high book-to-market ratios, while Growth stocks have a low book-to-market ratios. “Book” value is the valuation of assets less the liabilities on a company’s balance sheet according to accounting rules and principles. And “market” means the market price of a stock. Presented as a ratio, a higher figure would indicate that the company’s net assets are more valuable relative to the company’s stock (a Value stock), while a lower figure would indicate that the company’s net assets are less valuable relative to the company’s stock (a Growth stock).
Examples of Current Value Stock Investing
Click here to view John Buckingham’s Forbes Blog where he discusses individual Value Stocks in The Prudent Speculator Portfolio.
Reasons Value Stock Investing Is Attractive
Bargain, reliability/risk mitigation, diversification, dividends? 2% vs 1.3% (growth)
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Everyone loves a bargain.
Warren Buffett once said “Be fearful when others are greedy, and greedy when others are fearful.” Buying stocks at a cheap price and patiently waiting for time in the market to
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Risk mitigation and reliability.
We all know that the future is unknowable. Finding success with a value approach tends to be much less dependent on making accurate, long-term forecasts about the future.
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Diversification is key.
We like stocks and we like a lot of them. Expansive diversification stands to serve us well in two ways: further minimize the risk of individual stock ownership, while maximizing the likelihood of finding truly big winners.
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Expectations are reasonable.
Modest expectations for growth in future earnings, sales, dividends etc. when evaluating opportunities for investment ought to allow room for positive surprise while reducing the risk of loss.
Why We Focus on Value Stocks Investing
Most importantly, it works.
While broad market valuation measures are always of interest to us, we do not rely solely on them. Instead, our in-house quantitative algorithms sort through time series data for thousands of stocks each day to form the foundation for our managed account strategies. From there, the broad opportunity set is consolidated into short list of Value stocks, analogous to “fishing in the appropriate pond.”
Once the appropriate short-list is determined, we scrutinize individual equities on a multitude of company-specific factors the algorithms don’t assess. The result aligns with our view that there’s a pocket of Value in any market environment and we remain focused on uncovering bargain-priced stocks with significant appreciation potential.
Wish to learn more about value stocks and those that are held in our portfolio? Read more about Ten Value Stocks to Consider Buying.
