A Beginner's Guide to Value Stocks

What is a Value Stock?

You’ve might have heard the saying, “buy low, sell high”. Well, that’s pretty much the core idea behind value stocks.

These are stocks that are trading for less than what analysts think they’re actually worth. This might be due to temporary market conditions or even bad press that caused its stock price to drop.

Value investors believe that the market is underpricing these stocks and that the company will eventually bounce back. When it does, they hope the stock price will rise, giving them a nice profit.

You can think of value stocks a bit like finding a luxury handbag on sale. You know that the true value of the bag is worth a lot more than what’s written on the price tag!

Value Stock Definition

To make things even clearer, here is a definition of ‘value stock’.

“A value stock is a stock that trades at a price lower than its intrinsic value. The idea behind value investing is that the stock market sometimes undervalues good companies, often due to short-term factors like negative headlines or broader market trends. Value investors look at the company’s fundamentals to identify whether the stock is actually worth more than its current price.”

Intrinsic value: The true worth of a company, determined by analyzing its fundamentals—things like earnings, dividends, and cash flow.

Examples of Value Stocks

You’re probably wondering which well-known stocks can be classed as value stocks. Here are three examples that you might find in a value investor’s portfolio.

Berkshire Hathaway

Berkshire Hathaway is an investment company run by Warren Buffett, who is pretty much the poster child of value investing. Despite its massive success, there are times when its stock is priced lower than analysts think it should be.

Buffett’s strategy focuses heavily on buying undervalued stocks, which makes Berkshire Hathaway a classic example of value investing in action.

JPMorgan Chase

Another strong contender in the world of value stocks is JPMorgan Chase. The bank has a history of stable earnings, solid dividend payments, and a strong balance sheet. Yet, like many banks, its stock can sometimes trade at a low price, making it appealing to value investors who see long-term potential.

Proctor & Gamble

Although you might not have heard the name Proctor & Gamble, you have probably heard of brands like Pampers, Gillette, and Tide.

Proctor & gamble is the name behind these huge consumer goods brands. It’s a solid, stable company with a long track record of steady earnings and dividends. From time to time, its stock price dips below what many investors think is its real value, making it a popular choice for value investing.

The products that are offered by Proctor & Gamble have a steady demand which makes them a relatively safe bet for long term investing.

How to Know If a Stock is a Value Stock

So, how do you actually spot a value stock? While there’s no magic formula, there are a few key metrics that investors look for when identifying value stocks. Think of these as the clues that help you determine whether a stock is undervalued or not.

Low P/E ratio

One of the most popular ways to identify a value stock is by looking at its Price-to-Earnings (or, P/E) ratio. This ratio tells you how much investors are willing to pay for each dollar of the company’s earnings.

A low P/E ratio usually indicates that the stock is undervalued compared to its peers. So, if you see a company with a P/E ratio that’s lower than others in its industry, it could be a sign that the stock is a value stock.

High dividend yield

Value stocks often have higher dividend yields, which means they pay more cash to shareholders through dividends. The beauty of investing in these stocks is that, even if the stock price takes a while to recover, you’re still earning money in the form of dividends while you wait. It’s perhaps the truest form of passive income!

Low P/B ratio

The Price-to-Book (or, P/B) ratio is another metric that value investors like to use to spot a value stock. It compares a company’s stock price to its book value.

A low P/B ratio can indicate that a stock is undervalued, especially when compared to other companies in the same industry. Essentially, it means you’re paying less for the company’s assets than they’re actually worth on paper.

Value Stocks vs Growth Stocks: Which is Better?

I have already mentioned growth stocks at the beginning of this guide. Growth stocks are often seen as the opposite of value stocks – these are stocks that have a higher price but loads of room for growth. There is a bit of a debate about which stocks are the best to invest in. The truth is that it depends on your financial goals, risk tolerance, and investment timeline.

Growth stocks are companies that are expected to grow much faster than the overall market. They often reinvest their earnings back into the company to fuel expansion, so you won’t typically see dividends. These stocks can generate high returns if the company performs well, but they also come with higher risk.

Value stocks, on the other hand, tend to be more stable. They might not offer the same explosive growth potential as growth stocks, but they’re often less volatile and come with the added bonus of dividends. Many investors like to hold a mix of both value and growth stocks to diversify their portfolio.

Perks of Investing in Value Stocks

In the next section, we will take a look at why some investors might want to add value stocks to their investment portfolio.

Lower risk: Value stocks are often considered less risky than growth stocks because they’re typically established companies with strong fundamentals. This makes them a safer bet, especially during periods of market volatility.
Dividends: Many value stocks offer dividends, providing you with a steady income while you wait for the stock price to appreciate.
Room for growth: Because value stocks are undervalued, there’s potential for significant upside when the market eventually recognizes the company’s true worth.
Stable companies: Many value stocks are found in established, well-known companies with a history of success.

Risks of Investing in Value Stocks

While value stocks can be a great addition to your portfolio, they’re not without risks:

Value traps: Sometimes a stock is cheap for a reason. If a company is in serious trouble, it may never recover, and the stock price may continue to fall. This is known as a “value trap.”
Slow growth: Value stocks may not see the same rapid price increases as growth stocks, so you’ll need to be patient. This makes them best suited for long-term investors who have years on the clock!
Market sentiment: Even if a stock is undervalued, it could take a long time for the market to recognize its true worth. In the meantime, the price may stay low, which can be frustrating for investors looking for quicker returns.

How to Find Value Stocks

Now that you know what a value stock is and why they’re appealing, how do you actually find them?

Here’s what to look for!

Look for low P/E and P/B ratios: Use a stock research tool (or look through company earnings reports) to search for companies with low P/E and P/B ratios compared to other companies in the same indsutry.
Look for dividend-paying stocks: Many value stocks offer dividends, so check the company’s dividend yield as part of your research. Look for steady and stable dividend payments (it’s a good sign if a company has managed to consistently pay dividends for a long time!).
Check financial statements: Dive into the company’s financials to make sure it’s in good health. Look at things like earnings, debt levels, and cash flow to ensure the company is fundamentally sound.

Why Are Some Stocks Undervalued?

So, why are some stocks trading below their true value in the first place? There are several reasons this can happen:

Market overreaction: Sometimes, the market overreacts to bad news (we’re all human after all!), causing a company’s stock price to drop more than it should. Savvy investors can take advantage of this by buying the stock at a discount.
Short-term issues: Companies might experience short-term problems, like poor earnings in one quarter, that temporarily drive down the stock price. If the company’s long-term prospects are still good, this can create a buying opportunity.
Lack of recognition: Some companies fly under the radar and don’t get as much attention from analysts or investors. This can result in the stock being undervalued, even if the company is performing well.

Value investing is a bit like shopping for bargains—you’re looking for stocks that are underpriced relative to their true value. While it takes patience and careful research, investing in value stocks can be a great way to build wealth over time. By understanding what makes a stock undervalued and knowing how to spot the signs of a good value stock, you can make informed decisions and grow your portfolio.

Are you interested in learning more about investing? Why not sign up to the MoneyMagpie bi-weekly Investing Newsletter? It’s free and you can unsubscribe at any time if you find it isn’t for you.

investing newsletter

Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.

A Beginner’s Guide to Value Stocks