Value investing is an investment paradigm which generally involves buying securities that appear underpriced by some form of fundamental analysis, though it has taken many forms since its inception. It derives from the ideas on investment that Benjamin Graham and David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text Security Analysis. As examples, such securities may be stock in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios.
What is a ‘Value Stock’
A value stock is a stock that tends to trade at a lower price relative to its fundamentals (e.g., dividends, earnings and sales) and thus considered undervalued by a value investor. Common characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio. An easy way to attempt to find value stocks is to use the “Dogs of the Dow” investing strategy by purchasing the 10 highest dividend-yielding stocks on the Dow Jones at the beginning of each year and adjusting the portfolio every year thereafter.
Explaining ‘Value Stock’
A value stock is a security trading at a lower price than how the company’s performance may otherwise indicate. Investing in a value stock attempts to capitalize on inefficiencies in the market as the price of the underlying equity may not match the company’s performance.
Two Approaches to Selecting Stocks
The two basic approaches for equity investing relate to purchasing growth stock or value stock. Growth stocks are equities of companies with strong anticipated growth potential. Value stock emphasis equities that are currently undervalued. A balanced diversified portfolio will have both value stock and growth stock. These portfolios may be referred to as a blended portfolio.
How to Spot Value Stocks
A value stock will have bargain-price as the company is seen as unfavorable in the marketplace. A value stock will have an equity price lower than stock prices of companies in the same industry. Negative publicity relating to unsatisfactory earnings reports or legal problems are indicators of a value stock as the market will negatively view the company’s long-term prospects. A value stock will most likely come from a mature company with a stable dividend issuance that is temporarily experiencing negative events. However, companies that have recently issued equities have high value potential as many investors may be unaware of the entity.
Risk and Return of Value Stocks
A value stock is considered riskier than a growth stock. This is because of the skeptical attitude the market has towards the value stock. For a value stock to turn profitable, the market must alter its perception of the company, which is considered riskier than a growth entity developing. For this reason, a value stock is typically more likely to have a higher long-term return than a growth stock because of the underlying risk. The investing duration must be taken into consideration a value stock may need some time to emerge from its undervalued position. The true risk in investing in a value stock is that this emergence may never materialize.
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