Value stocks: how they work and key metrics for trading
Value stocks offer opportunities for traders to benefit as they increase in price, but they can be very different from cheap stocks. It’s worth understanding what value stocks are, why they may be priced lower, metrics used and growth potential.
IN A FEW WORDS
Value stock What are value stocks Value stock list Best value stocks 2021 Value stocks vs growth stocks High value stocks
4 min reading
As any experienced bargain hunter will attest, there's cheap and there's good value. Some things are cheap for a reason. Plenty of stocks will be cheap, but that's not what gets a value investor excited. The best value stocks for 2021 are those where the market has fundamentally misunderstood their growth prospects. So, what are value stocks and what should investors be looking for?
High value stocks can be relative
In uncovering value stocks, investors will look both at whether a stock is cheap relative to its intrinsic value, but also whether it has prospects for recovery. The premise of value investing is that good quality stocks occasionally become unfashionable, and if you can buy them at a lower price, you can make money. This is very different to buying bad companies at a low price and hoping they may become less awful.
A range of factors can mean companies are undervalued
It may be as simple as investors misjudging the growth prospects for a company. If a company is valued as if it will grow at 5% and it looks set to grow at 20%, it will be undervalued. As such, while many people think of value stocks as low growth, this isn’t necessarily the case.
Sectors become unfashionable. When everyone is looking at technology or green energy, they may not be paying attention to, say, media or financials even though there could be great businesses in those sectors. The same may be true for countries. A technology company in the US may garner lots of attention, but a similar company in the UK may not come onto the radar.
It may also be that a company has short-term problems that the market over-interprets. For example, supply chain concerns can cause short-term damage to profitability, but may be quickly resolved. The share price may drop as investors lose their nerve. This can be an opportunity for the value investor.
There may also be cyclical fluctuations in a company’s performance. Certain companies tend to do particularly well in a buoyant economic climate, but it can leave them neglected during difficult periods. Investors can assume that a cyclical downturn is structural and the share price may fall below a company’s intrinsic value.
Various metrics help to determine a company’s relative value
These will generally work in combination, rather than as single metrics:
- Price-to-earnings ratio (P/E) – a company’s share price, divided by its earnings. A low P/E ratio can suggest a company is lowly valued, but the ratio doesn’t measure whether a company is growing its earnings or whether it has had a temporary blip.
- Price-earnings to growth ratio (PEG) – the same as the P/E ratio but brings in a measure of how fast earnings are growing.
- Debt-equity ratio (D/E) – compares a company’s total debt to its shareholder equity. Higher ratios tend to indicate a company with higher debt, which would usually be judged as higher risk investments.
- Return on equity (ROE) – a measure of how much money a company makes on its investments. A high ROE ratio shows whether it is investing wisely or whether it is deploying its cash sensibly.
- Dividend yield – a company’s dividend payout relative to its share price. In general, a high yield can indicate a ‘cheap’ company but can also show that the market expects the dividend to be cut.
- Price-to-book ratio (P/B) – a measure of a company’s share price relative to its assets. It is calculated by dividing the company's stock price per share by its book value per share. Book value is usually asset value less its liabilities.
It doesn’t have to be value versus growth stocks
Value and growth are equally valid approaches to selecting stocks. Growth focuses on how fast a company is growing, while value focuses on the price paid. In reality, they are two sides of the same coin. Value investors still want to find businesses with long-term growth prospects, while growth investors don’t want to over-pay.
Ways to invest in value stocks
Value stocks can be found in any sector, depending on the market environment. Many investors will want to compile their own value stock list – perhaps by looking in unfashionable sectors such as retail, leisure or others hard-hit by Covid. Another option is to look at some of the companies that appear in the key ‘value’ indices: the S&P 500 Pure Value Index, MSCI World Value Weighted Index and Russell 3000 Value Index. It is also possible to find ETFs based on these indices, which can give diversified exposure to value stocks.
The alternative is to find a good active manager. Jupiter is just one example with a well-respected value team; its Jupiter Income Trust is a potential option for those who believe in the value approach.
The Fineco trading platform offers a range of options for potential bond investors, with all the tools you need and clear, fair lets you trade across a broad range of markets, indices and currencies, all from a single account with clear fair pricing.
Information or views expressed should not be taken as any kind of recommendation or forecast. All trading involves risks, losses can exceed deposits.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 70.82% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Fineco Newsroom is a compilation of articles written by our editorial partners. Fineco is not responsible for an article's content and its accuracy nor for the information contained in the online articles linked.
These articles are provided for information only, these are not intended to be personal recommendations on financial instruments, products or financial strategies.
If you’re looking for this kind of information or support, you should seek advice from a qualified investment advisor.
Some of the articles you will find on the Newsroom feature data and information from past years. As per the very nature of the content we feature in this section of our website, some pieces of information provided might be not up to date and reliable anymore.
This advertising message is for promotional purposes only. To view all the terms and conditions for the advertised services, please refer to the fact sheets and documentation required under current regulations. All services require the client to open a Fineco current account. All products and services offered are dedicated to Fineco account.