Looking to find quality stocks trading at bargain prices?
This is known as investing in value stocks. In this lesson, you’ll learn what value stocks are, their key characteristics, and examples of some of the top value stocks you can buy right now.
What are value stocks?
Value stocks are stocks of companies that are trading at lower prices than that of other similar companies in the same industry. What makes these stocks potentially attractive buys is that they still sport solid fundamentals and have plenty of potential to grow.
Why do investors look for value stocks?
If you’ve ever heard the old stock market adage, “buy low, sell high,” you understand the appeal of value stocks. Investors will sometimes undervalue stocks that are in perfectly fine shape fundamentally. Bargain hunters peruse what’s called stocks’ intrinsic value, measuring this by such metrics as earnings per share, price-to-earnings ratio, and price-to-book ratio. Find those stocks whose price lags behind those metrics, and you could end up buying low on a potential big winner.
What are the defining characteristics of value stocks?
1) Strong earnings per share
This is the characteristic that defines winning stocks of all stripes, be they value stocks or growth stocks. You want to invest in companies that sell products or services in high volume at healthy profit margins, resulting in strong earnings per share.
2) Low price-to-earnings ratio
This is where the value in value stocks comes in. You’re looking for stocks that boast strong earnings per share, but with prices that lag behind their industry peers. To calculate price-to-earnings (P/E) ratio, simply divide the stock’s current price by its earnings per share. If you don’t know the stock’s earnings per share, you can calculate it by subtracting that company’s dividends from its net income (assuming this is a stock that issues dividends), then dividing by the number of shares outstanding.
3) Low price-to-book ratio
Another measure of a stock’s intrinsic value, the book value of a stock is its value according to its balance sheet. It’s based on the cost of the asset minus depreciation and amortisation costs. You can calculate price-to-book (P/B) ratio by dividing a company’s stock price by its book value per share.
4) Different reasons for being undervalued
Value stocks are characteristically undervalued, but there are a variety of reasons why this happens. Here are a few of the reasons why investors might undervalue a stock that sports strong fundamentals:
- Bad news. A mining company’s stock could fall sharply because miners decide to strike, halting work and hurting production. Investors must figure out if that strike constitutes an enduring problem for the company’s stock, or if it offers an opportunity to buy low.
- Seasonal business. The stock of a company that owns and operates swimming pools might see its biggest gains leading up to summer, only to trade at undervalued prices in the winter, when far fewer people swim in pools.
- Cyclical business. Stocks of cyclical businesses go down when overarching economic conditions turn against them. For instance, hotel companies’ stocks have been hammered in 2020, because the COVID-19 pandemic has crushed demand for both business and leisure travel.
- Bear markets. All stocks are at risk of falling sharply during bear markets. That includes value stocks, which might look undervalued based on their P/E or P/B ratios, only to tumble anyway as the broader stock market wreaks havoc everywhere.
- Lack of interest. Sometimes you’ll find a stock that’s undervalued based on its fundamentals for no other reason other than it’s flown under the radar. Perhaps this stock trades in light volume, making it less attractive to big-money institutional investors who prefer more liquidity. Perhaps the stock hasn’t garnered the flashy news media headlines that some of its peers have landed. Whatever the reason, it’s simply struggled to attract attention, keeping its price suppressed.
Here are some examples
If you’re looking to put your money in value stocks, then here are some of the best currently around.
1) MGM Resorts International (MGM)
As you might expect, tourism and hospitality stocks offer some of the biggest potential bargains, given the global lockdowns that have paralysed both business and tourism travel. As of early June 2020, hotel and casino chain MGM showed a microscopic price-to-earnings ratio of just 4/1.
2) Southwest Airlines (LUV)
In a similar vein, airline stocks have dropped sharply in price during the massive drop in air travel during the COVID-19 pandemic. When air travel starts to pick up again, Southwest Airlines (early June P/E ratio of 11/1) stands to benefit.
3) NRG Energy (NRG)
NRG has no ties to the tourism and hospitality industry, but it’s a potential bargain in its own right. The electricity generation company sports a P/E ratio of just over 2/1 as of early June 2020, even after its stock climbed more than 50% off its March 2020 lows.
4) Apogee Enterprises (APOG)
Specialising in the design and development of glass products for commercial building windows, framing art, and other uses, Apogee might not resonate as the sexiest business model. But with a P/E ratio below 12/1 as of early June 2020, it could be a viable option as a value stock.
How do I find value stocks?
You can find the best value stocks by using screening tools available at investing websites such as MarketWatch and Yahoo Finance. There, you can search for value stocks based on parameters such as P/E ratio. But you don’t have to go anywhere at all, as you can also find the best value stocks right here, via our lists of top-performing value stocks that we publish once a month on this site.
So, now you have a grasp on value stocks, click to check out our next lesson and keep learning – next up is dividend stocks.