“Value stocks” describes an investing strategy that looks for companies currently trading below what they’re truly worth.
Many investors confuse value stocks with safe stocks, dividend stocks, and blue chip stocks. They're not the same.
What exactly is a value stock?
“Value stocks” describes an investing strategy that looks for companies currently trading below what they’re really worth.
In other words, value investing tries to buy good stocks on the cheap.
There’s no strict definition of what makes a company a value stock, and technically any company could be a value stock at any time.
For example, if a stock had a fair value of roughly $100 per share, but was trading for $120 per share we would call it “overvalued.” However, if the very next day the stock sold off by 33% so it was now priced at $80, you could definitely call it a value stock.
This is a very important point: Unlike dividend stocks, small cap stocks, or a growth stocks, which all tend to stay what they are, value stocks can move in or out of being “value stocks.”
Value stocks are in an undervalued state right now because they’re trading at a price well below what they should be trading at (based on their true fair value).
Now that brings us to the million dollar question: How do you know what the fair value of the stock should be?
Therein lies the entire art and science of value investing.
The price of a stock, on its own, tells you absolutely nothing about whether it's undervalued or overvalued.
I cringe when I hear investors say, "Oh that stock is trading for $150, that seems expensive."
The stock price only matters relative to the value of the underlying company. You have to ask what you're getting for the price to decide if it's cheap or expensive.
For example, shares of Berkshire Hathaway (BRK.A) are currently trading at $310,000 per share whereas shares of small cap pharmaceutical stock SCYNEXIS (SCYX) are currently trading at $1.19 per share.
I believe I could successfully argue that Berkshire trading at $310,000 ($238B in sales and $48B in income over the last 12 months) offers a much better value than SCYNEXIS trading at $1.19 ($0 in sales and -$31M loss in income over the last 12 months).
It's not about the price of the stock. It's about how much you get for what you pay.
I've noticed that investors sometimes confuse “blue chip stocks” with “value stocks.” They’re not the same.
A blue chip stock is generally a large, well-known, high-quality industry leader with reliable financial performance and growth.
A value stock can be any company that is currently undervalued. Yesterday it could’ve been overvalued, and after a selloff today it's now undervalued. Tomorrow it skyrockets and is overvalued again.
It’s true that value stocks often stay undervalued for a period of time and don’t tend to swing as wildly as the imaginary scenario above.
And there are value stocks that seem permanently stuck in undervalued territory. We call them “value traps” because although they appear undervalued, they often struggle to return to a fair valuation, instead languishing or declining further.
In other words, sometimes a stock is cheap for a good reason: it’s a bad business.
Classic stocks like General Electric (GE), Procter & Gamble (PG), United Technologies (UTX), Coca-Cola (KO), and Johnson & Johnson (JNJ) aren’t necessarily value stocks; they’re more blue chips stocks.
However, any one of them could certainly be considered a value stock if it’s currently undervalued.
Sometimes unexciting low growth stocks are grouped together as being typical "value stocks" (for example, utility stocks or industrial stocks) and exciting high growth stocks (for example, tech stocks or biotech stocks) are grouped together and considered "overvalued."
While there's some general truth to that type of grouping, I think there's a better way to think about it.
Rather than asking, "is this a value stock or not?", investors should ask "how undervalued or overvalued is this stock?"
Again, an unexciting utility stock can be wildly overvalued while a biotech micro cap stock can be dramatically undervalued. It's all about what you get for what you pay.
Every stock has a valuation and it doesn't make sense to only think about value with "boring" stocks. You should be thinking about valuation with every stock you buy.
A successful value investing strategy has three big benefits:
Over 100 years of extensive research has shown that buying value stocks is one the best strategies for making money and beating the market. Over time, it has consistently outperformed most other investing strategies.
There’s just one catch: Value investing can have long stretches of underperformance. For example, classic value investing hasn’t worked very well for the last 5+ years. The market has been mostly driven by high growth stocks.
Classic metrics used to measure if a value stock is cheap include price to earnings ratio (P/E ratio) and price to sales ratio (P/S ratio). Price to book ratio (P/B ratio) is another metric made famous by legendary value investor Benjamin Graham in the 1930’s and 1940’s.
That being said, there are other (more advanced) methods and strategies to measure value that have consistently performed well.
|Value Stock||Company Name||Recent Price||P/E Ratio (TTM)||Price/Sales (TTM)|
|KLIC||Kulicke and Soffa||$20.87||21.97||1.59|
|UEPS||Net 1 Ueps||$7.00||10.29||0.65|
Based on our proprietary stock research, these 30 stocks are currently undervalued.
To be clear, we’re not recommending that you go buy these value stocks now. While value is important to consider when looking for the best stocks to buy, it’s critical to consider other factors as well (for example, growth, dividends, management, etc).
Also, similar to what we found with dividend investing (Buy the Best High Dividend Stocks with This Research-Backed Formula), it’s actually not best to buy the MOST undervalued stocks. Value stocks in the 80-90th percentile in terms of undervaluation seem to perform the best. In other words, you want to buy a solidly undervalued stock trading at a discount, but not one trading at absolute rock bottom prices.
Based on our research and experience, you should absolutely consider valuation when adding stocks to your portfolio. While other strategies have performed better recently, it’s critical to avoid buying overvalued stocks. So always keep your eye on value.
Data as of 10/11/18
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