Value Investing
Value investing involves buying securities that, based on fundamental analysis (studying financial statements or business positioning), are trading below their intrinsic worth or at a discount to the market or their peers. Value investors consider various financial performance metrics, including price-to-earnings (P/E) ratio, price-to-book (P/B) ratio and many others. They might also contemplate business or economic trends that they expect will impact an investment’s prospects over time.
Identifying Value Stocks
Which precise metrics qualify a stock as value is subjective, but they generally include measures like a low P/E, low P/B or other indications that it might be undervalued. Value stocks are often more mature businesses. Other value shares are formerly “hot” stocks that have since fallen on hard times. An investor who believes the company’s struggles are temporary or overblown might consider it a value investment.
Underlying the concept of value investing is the idea that if you consistently buy $1 worth of stock for 50 cents, over time you’ll make money. The belief is that if your holdings truly represent good value, the market will eventually adjust to reflect this, resulting in profits for you. Even if your view of a company’s prospects proves optimistic, buying at a low valuation can help cushion the downside.
Patience Is a Virtue
Value stocks don’t usually benefit from the sort of hype that often envelops a trendy company or industry. It might take years for the broad investment community to change its sentiment regarding out-of-favor stocks. Unlike momentum investors—who might anticipate that recent gains will lead to further short-term profits as fear of missing out (FOMO) takes hold—value investors expect to be rewarded for their patience. Those seeking the adrenaline rush of momentum plays are rarely attracted to value investing.
Value investors won’t embrace a security solely because it’s unwanted. They want to see numbers (like a low P/E or P/B) demonstrating the shares are currently at a significant discount to their true worth, as viewed by these investors.
Keep in mind that not every stock with a low P/E or P/B represents true value. Sometimes stocks sell off due to a deterioration in their fundamentals that’s not yet commonly understood and thus not reflected by lower earnings or future earnings estimates from analysts. In this case, a stock might seem like a bargain at its current valuation, but some market participants might be avoiding the shares because they recognize the company’s reduced prospects.
You can also follow a value-based strategy by investing in value-oriented mutual funds or exchange-traded funds (ETFs). Compare funds using FINRA’s Fund Analyzer.
Consider working with an investment professional to help you determine the best investment strategy to achieve your individual financial goals.
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