The concept of value investing was popularized by Benjamin Graham, back in the 1930s. In his famous book “The Intelligent Investor”, Ben Graham described the approach for a value investor, along with few other important concepts like Mr Market & Margin of safety.
A value stock is a security trading at a lower price than what the company’s performance may otherwise indicate. Investors in value stocks attempt to capitalize on inefficiencies in the market, since the price of the underlying equity may not match the company’s performance.
Understanding Value Stock
Value Stocks have completely different characteristics than Growth stocks. These companies do not have a very high growth rate, rather they grow slow. However, these stocks trade at a low valuation and low market price.
Value investors look at investing in stocks as buying the super cheap company which are trading below their true potential or true value in the market. They find the company’s intrinsic value using the fundamental approach of calculating valuations by reading its quarterly and annual reports.
How To Identify Value Stock
A value stock will have a bargain-price as investors see the company as unfavorable in the marketplace. Typically, a value stock has an equity price lower than the stock prices of companies in the same industry. Value stocks may also sit within a sector that trades at a discount to the broader market.
A value stock will most likely come from a mature company with a stable dividend issuance that is temporarily experiencing adverse events. However, companies that have recently issued equities have high-value potential as many investors may be unaware of the entity.
There are a number of financial ratios that can be used to determine an undervalued stock in the market. Two of the most commonly used fundamental indicators are the Price to Earnings Ratio (PE Ratio) and Price to Book Value (P/BV) Ratio.
P/E Ratio- The Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share (EPS). It is a popular ratio that gives investors a better sense of the value of the company. The P/E ratio shows the expectations of the market and is the price you must pay per unit of current earnings
P/B Ratio- The price to book value ratio, or PBV ratio, compares the market and book value of the company. Imagine a company is about to be liquidated. It sells of all its assets, and pays off all its debts. Whatever is left over is the book value of the company. The PBV ratio is the market price per share divided by the book value per share. For example, a stock with a PBV ratio of 2 means that we pay Rs 2 for every Rs. 1 of book value. The higher the PBV, the more expensive the stock.
Value investors prefer investing in stocks with a lower PE ratio and lower PBV ratio.