Value stocks are the stocks of those companies that seem to be underappreciated by the market. Since these stocks tend to trade at prices lower than their fundamental value, they are preferred by value investors. A value investor is one who buys an undervalued stock with the hope that the market will eventually recognize the underlying value of the company, causing the share price to rise.
According to empirical data, value stocks have consistently outperformed growth stocks as well as the market as a whole.
Moreover, a study conducted by the US-based Brandes Institute over the 28-year period ended December 2006 indicates that value
stocks outpaced growth stocks of both large and small companies in the country.
For investors opting for value stocks, bearish trends in the stock market represent an opportunity to buy high-quality
stocks at low valuations. Buying a value stock is termed as value investing.
Common Features of Value Stocks
A recent decline in share prices does not qualify stocks as value stocks. Deterioration in the fundamentals of the company
may result in pressure on its stock.
The common characteristics of value stocks are:
- They yield high dividends.
- They have a low price-to-book ratio.
- Their price-to-earnings (P/E) ratio is low.
How to Trade in Value Stocks
A value investor believes that one can always identify stocks that are trading at prices significantly below what
reflects the true worth of the company, since the stock market is not at its efficient best at all times.
Steps to trade in value stocks are:
- Seek out potential buys. Start your search by identifying companies that have been performing consistently. From this list of companies, select the ones that depict the characteristics of a value stock.
- Conduct a thorough research of the companies that you believe to be value stocks. If the company is generating healthy cash flows and earnings, fluctuations in the share price can be overlooked.
- Compare identified value stocks with others in the same industry in terms of P/E ratio, return on equity (ROE), gross and net profit margins and the growth rate of earnings and revenues.
- Buy selected stocks from discount brokerages, which take low commissions from do-it-yourself investors.
- Hold the stocks until the market recognizes the underlying value of the companies.
- Sell the stocks or retain them for the long term, depending on your confidence in the company’s fundamentals.