The Basics of Value Stock Investing

By Stock Research Pro • September 14th, 2009

Value Stock is a term used to describe a stock that is trading at a price that is less than its real or “intrinsic” value as determined by its fundamentals. Value investors employ a strategy of finding stocks that are trading at a deep discount when compared to the intrinsic value; the size of the discount is referred to as the “margin of safety”. Benjamin Graham and Warren Buffett are among the best-known value investors.

Identify a Value Stock

Stock screeners offer a great tool for investors to filter for viable stock investment candidates and for value investors offer an efficient way to plug-in the characteristics of a stock that would meet a value investor’s criteria. The attributes of a value stock can include:

Low Price/ Earnings (P/E) Ratio: Price/Earnings is a valuation measure that shows how much investors are willing to pay for each unit of earnings for a given company. While high P/E ratios demonstrate investor optimism for that company, it can also mean the stock is overvalued. Value investors often look for companies whose P/E ratios less than 20 and lower than others in the same industry. All else being equal, the low P/E company would be cheaper.

Low Price/Book (P/B) Ratio: The Price/Book ratio compares the book value of a company to its market value to help investors measure the relative value of a stock. A company’s book value is an accounting firm to measure the value of a company by the sum of its assets. Value investors often look for a P/B ratio of less than 3 and lower than its industry peers.

High Dividend Yield: The dividend yield tells investors how much the company is pays out in dividends relative to its current share price. As such, the dividend yield measures cash flow for a stock investment. For value investors, a dividend yield that is 50% higher than market and industry average is often desirable.

Debt/ Equity (D/E) Ratio: The Debt/Equity ratio shows the proportion of company equity and debt used to finance its assets. Debt/Equity provides demonstrates the relationship between levels of capital contributed by creditors and company shareholders. A Debt/Equity ratio that is 10% lower than the industry average would be seen as attractive.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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