With the rise in stock market volatility this year, value investing is back in the spotlight.
In value-style investing, fundamentals take the lead. A stock is considered a good value when its price seems to be too low relative to the strength of the company’s financial performance. Often the stock is trading at a price lower than that of its peers in the same industry.
Value stocks tend to outperform in more volatile markets as investors seek safety and search for companies that are well established with proven track records. By contrast, growth stocks, which have driven the most recent bull market, tend to be newer companies, sometimes with little to no track record of earnings, but with high expectations for future growth. The primary catalyst for investing is the expected growth that the company will achieve. The stock can surge very quickly and may see larger more spiked returns as opposed to the steadier and slower returns expected from a value stock. Growth stocks are also considered to be more risky. If the expected growth is not attained, there is nothing to fall back on and the stock price can plummet.
The value approach to stock selection relies to a lesser extent on market factors and focuses on companies with strong financials that may have been dragged down by other factors within the industry sector, or along with the overall market.
Consider an industry that is experiencing increased pricing pressure as an example. Some firms may not be able to withstand the competitive pressure and profits could decline. All stocks within the industry may experience a pullback as this news is digested by the market. A good value buy would be a company that the investor feels has the resources, competitive edge and financial strength to outpace its competitors and come out on top. The value investor feels that the market has overreacted to news and will look to buy these stocks at prices lower than the historical average or lower than others in the industry. Sometimes this can take a long time, and the risk is that it will never materialize. It is critical to be mindful of why a stock is trading at a bargain price.
Some key principles to consider when evaluating potential value stocks are as follows:
Price-to-earnings ratio (PE ratio). This is a company’s stock price divided by its earnings per share. It tells you how much you are paying for each dollar of earnings. It is used as a way to value a company and compare it to the general market or to other companies in the same industry. A lower PE ratio in comparison can indicate that a stock is cheap.
Earnings record. An investor would look for a strong earnings history with five years plus of consistent earnings moving in an upward direction.
Low Debt. Debt level should be evaluated in comparison to others within the same industry. Capital intensive industries for instance will naturally carry more debt. A low level of debt is generally better, but further research may be needed beyond the outright debt level. A company that is highly leveraged could be cause for concern; however it could also mean it has invested smartly in a project that will increase growth prospects and profitability down the road.
Price-to-book value (P/BV ratio). Simply stated, book value is the value of the company that will be remain, after liquidating all of its assets and paying off its liabilities. It is a useful data point to determine if a stock is cheap. A stock that is trading at or below the underlying book value of the company, (around 1 or less) may be an attractive buy. It should be noted that BV is more useful in some industries than others as it does not take into account intangible assets such as brand recognition, goodwill or intellectual property.
Dividends. alue stocks tend to sport a higher dividend rate. This works well to provide supplemental return while waiting for the stock price to appreciate. A dividend that is growing is even better.
Value stocks typically take longer to rise. As such these types of investments align well with investors that are patient and have a longer term time horizon.
Note: Donna St.Amant, MBA, is a Portfolio Manager at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit.
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