Value stocks are underpriced stocks and the investment strategy of investing in value stocks is known as value investing. The concept of value investing was introduced in 1928 by Benjamin Graham and David Dodd.
What Are Value Stocks?
The ‘Value’ of a thing comes from the benefits it can offer. You may buy a thing if the value you assign matches or exceeds its price. That concept also exists in the stock market world.
Each stock has an intrinsic value assigned to it after considering its fundamentals. Based on the demand and supply, each stock will have a market price which may be equal to, lower or higher than its intrinsic value. Thus, Value stocks are those stocks which seem to trade at prices lower than their fundamentals suggested values. The basic premise behind investing in value stocks is to identify them before the market, buy them at a lower price, and gain greater returns when the market realises their actual worth.
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Features Of Value Stocks
Lower P/E ratio
Price-to-earnings is a crucial metric for finding value stocks. It evaluates the relationship between the current market price per share and earnings per share (EPS). Earnings per share mean how much revenue a company generates for each share. Thus, a lower P/E ratio indicates that the company’s stock price is lower than what it should be based on its earnings. The ideal P/E ratio differs among industries.
Lower P/B ratio
As the name implies, the Price-to-book ratio compares a company’s stock price with its book value per share.BV per share means subtracting the firm’s total liabilities from total assets and dividing the resultant figure by the total outstanding shares of the firm. Thus, a lower P/B ratio may mean the stock is undervalued as it trades at a lower price than its book value.
Higher Dividend Yield
The dividend is a part of the profit the company distributes to its shareholders. The dividend yield is the annual dividend that the company offers as a percentage of its stock price. For instance, if the stock trades at ₹50, and pays an annual dividend of ₹5 per share, then the company is said to offer a 10% dividend yield. Thus, some of these stocks tend to give higher dividends to their investors.
Sound Qualitative Factors
Other than the above-mentioned quantitative factors, a company may have some qualitative factors that suggest higher future growth potential. It may have a good business management team or a competitive advantage that helps it stand out among its peers. Thus, a company having such factors with a lower stock price than its competitors may be under.
What is the Best Way to Invest in Value Stocks?
Having a Demat account, one can invest in any stock. You need to find the FV of stocks and then compare that with their market prices to assess. However, identifying undervalued stocks requires time, skills and knowledge.
For investors falling short on any of these, another better way to invest in value stocks is through value funds.
It helps investors to save time, and the fund manager’s skills and experience may increase the investment decision’s accuracy. Moreover, investors may benefit from diversification by investing in value funds.
Difference Between Over And Undervalued Stocks
|Point of difference||Undervalued Stocks||Overvalued Stocks|
|Meaning||These stocks are traded at a lower price than their intrinsic value.||These stocks are traded at a higher price than their intrinsic value.|
|Features||They are usually characterised by lower P/E ratios, lower P/B ratios, higher dividend yield, etc.||They are usually characterised by higher P/E ratios, higher P/B ratios, lower dividend yield, etc.|
|Reasons||Some reasons for stocks being undervalued are market/economic slowdown, negative press coverage of the company, small size, inadequate display of the company’s workings, etc.||Some reasons for stocks being overvalued are the bullish phase/economic boom, positive press coverage of the company, big size, seasonal fluctuations, etc.|
Limitations of Investing in Value Stocks
Difficult to identify
One of the drawbacks associated with these stocks is that identifying them is a difficult task. There is no single method to calculate the intrinsic value. Moreover, one requires finance-related knowledge and research, analytical, and decision-making skills to find them at the right time, which all investors may not possess.
There are chances that some stocks seem undervalued, though not worth your investments, and falling into such value traps may leave you with significant losses. It is better to consider multiple factors to find stocks and check their fundamentals periodically to avoid such traps.
Long holding period
Many value stocks take too long to arrive at their fair values and may not offer quick gains. This can happen even if you hold them for longer, there is no guarantee that they will reach your assigned fair values. In the worst scenario, one may need to exit them with a loss.
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