What are Value Stocks and How to Identify Them

For investors looking for a balanced way to invest in the stock market, value stocks tend to provide positive solutions. Value stocks are stocks of certain companies, perceived as undervalued by the market. The companies yielding value stocks portray sound financial metrics and strong fundamentals. However, stocks of such companies trade at a lesser price relative to their intrinsic value.  

Nonetheless, spotting stock with low value isn’t the only way to go about investing in value stocks. Investors should be aware that value stock investment is a long-term strategy of investment that translates to identifying undervalued businesses and holding stock patiently, till the true value of the stock is realised. Benjamin Graham popularised the technique of value investing when he mentioned it in his book, “The Intelligent Investor”. Furthermore, Warren Buffet, an ardent student of Graham, has followed the value investing strategy, making him one of the richest men in the world today.  

What is value stock? 

Value stocks are a boon for investors who may want stability in their investment in the stock market. Value stock represents a company or organisation’s stock that trades at a lesser price than its true or intrinsic value, depending on several fundamentals and financial measures. Typically, the market overlooks such stocks, undervaluing them because of particular factors like negative news and information about the company in question, economic downturns, or market volatility.  

Investors who have a low-risk profile tend to seek out value stocks and would rather go in for a value investing method than invest in growth stocks which tend to come with greater risk. Value investors look for undervalued companies, study their data, and invest in their stocks with the belief that the market will ultimately realise the company’s authentic value. When this occurs, investors expect the stock price to rise with substantial returns for the investor.  

How do value stocks work? 

Now that you have the answer to the question, “What are value stocks?”, you can move ahead to find out how value stocks work. The way that value stock investing works is quite simple. The first thing that investors do is identify stocks that are presently low in price (low in value). Essentially, this can be determined by different financial metrics like the P/E (price-to-earnings) ratio, and P/B (price-to-book) ratio, as well as the dividend yield.  

The mindset of the value investor considers that the market is inefficient in its valuation of stocks and hence, undervalues some stocks because of specific temporary variables like negative news about the company in question or market volatility. Hence, when value stocks are bought by investors, they are held for long periods, expecting that the market will eventually correct itself regarding the stock in question and realise its right value. During the time when investors hold the stock, they have the advantage of earning dividend payments in case the company wishes to share its profits with shareholders.  

Value stocks do not provide investors with the same degree of growth relative to growth stocks. However, they offer steady returns across long-term periods. Nonetheless, you should consider that when you invest in value stocks, there is some level of risk involved as not all stocks that are underpriced may perform as you expect them to. Additionally, market conditions and the economy can experience changes and this affects the performance of value stocks, just as it would any other investment you may consider.  

How to Spot Value Stocks

Investors can spot value stocks by analysing the fundamentals and financial metrics of the companies issuing them. Once you know the answer to the question, “What are value stocks?”, you undergo specific steps to decide which ones to invest in. Here are key steps to follow: 

1. Locate Companies with Low P/E Ratios: The first thing to do is seek out companies with low price-to-earnings (P/E) ratios. This is a metric that compares the current stock price of a company with its earnings-per-share (EPS). If the P/E ratio is low relative to the market or industry average, then this implies that the company in question may be undervalued.  

2. Find Companies with Low P/B Ratios: Next investors may seek companies with low P/B (price-to-book) ratios, as this compares a given company’s market value to its book value. This is the value of its assets with liabilities subtracted. A company that has a low P/B ratio compared to the market or industry average indicates undervaluation of the company and that it is issuing value stocks.  

3. Seek Companies that Have a High Yield of Dividends: This is a metric that reflects the number of dividends that are paid per equity share compared to the present stock price of the company. In case a company portrays a high dividend yield against the market or industry average, this suggests that the said company is undervalued.  

4. Study a Company’s Financial Data: Before you invest in value stocks, you must assess a company’s financial statements. Have a good look at the company's cash flow statements, balance sheets, and income statements to gauge its financial stability and overall fiduciary health. Companies that have robust financials and stable earnings growth over time may be undervalued currently, but they have potentially positive prospects in the future.  

5. Identify Overlooked Companies: Certain promising companies may have been underpriced or overlooked by the industry or market. Investors need to search for these companies by researching market trends and industry factors. Value stocks may arise from companies that have robust competitive edges, solid management, and clear growth trajectories, but have somehow gone unnoticed.  

Importance of Valuation of Stocks 

The valuation of stocks must be undertaken for a very simple reason: to know the value of particular stocks that may influence any investor’s investment decisions. Once you know how to identify value stocks, you should also know why the valuation of stocks is relevant. Here are the key reasons:  

• Helps in the Identification of Undervalued and Overvalued Stocks 

Valuation research and analysis aid investors in the determination of the correct value of any company’s stock. This analysis is conducted by researching a company’s earning prospects, financial information, and other company fundamental aspects. Such an analysis helps investors in detecting stocks that may be undervalued but whose value may substantially increase in the future. On the other hand, this kind of analysis aids investors in finding overvalued stocks that may prove risky.  

• Aids Investors in Investment Decision-Making 

After doing adequate research to identify value stocks, investors can make informed and appropriate investment decisions. By understanding the worth of a company through quantitative analysis and fundamental analysis techniques, investors can make rational investment decisions.  

• Assists in Hedging Risk

Once investors gain valuable insights into a company’s data concerning its financial health and prospects, they can get a potentially good idea about where the company is headed. The analysis of a company lets investors know about the company’s financial position overall, position in the market or industry, and debt levels, among other company-related variables. This permits investors to make decisions about investing in value stocks according to their risk profile and helps them manage/hedge potential risk.  

• Valuation Offers a Benchmark 

Investors gain a good understanding of a company through valuation analysis over periods. Such an analysis offers investors a benchmark of a company’s performance against metrics like financial position, revenue, and return on investment relative to industry standards. In this manner, investors can get a clue about whether a company is delivering optimal returns to shareholders or fulfilling its financial objectives.  

Example of Value Stock 

You can find many examples of value stocks in the market. Now that you have answers to the question, “What is a value stock?”, examples may help you grasp the concept better:  

• ExxonMobil (XOM): A player in the oil and gas segment of the industry, ExxonMobil has witnessed a stock price fall in recent times because of plummeting prices of oil and other challenges in the industry.  

• Johnson & Johnson (JNJ): A household name in the healthcare industry, this company’s stock may fall within the “value stocks” category as it has strong financials and a solid foundation but has seen decreases in the price of its stock.   

• AT&T (ATT): A veritable giant in the telecommunications sector, AT&T has a low P/E ratio relative to the industry average, plus a high dividend yield. The brand remains robust, while the company tries to overcome challenges from technology and trends in the industry.  

Conclusion 

Value stocks may be considered by those investors who don’t mind holding equity for the long run, patiently waiting for returns. Value stocks may be considered the true investment channel for “real” investors who see value in a presently undervalued stock at some point in the future. However, before investors take the leap into investing in value stocks, a thorough valuation analysis must be done to ensure investments potentially yield optimal returns.