What Are Value Stocks: A Detailed Explanation

ByG. Dautovic
February 11, 2022

A value stock refers to shares of a business that appear to be trading at a low price compared to the fundamentals of the business, such as sales, earnings, or dividends. As such, value stocks are highly appealing to investors.

In this guide, we will reveal everything you need to know about value stocks and provide you with some investment tips. 

What Are Value Stocks?

A value stock is a security that trades at a reduced price compared to the performance of the business in question. As opposed to expensive stocks, people who invest in value stocks look to capitalize on the market’s inefficiencies, as the price of the underlying equity might not match the performance of the company, so it’s almost certain to increase.

Some of the stocks characteristics you are likely to find in a value stock include a low price-to-earnings ratio (P/E ratio), low price-to-book ratio (P/B ratio), and a high dividend yield. Investors can locate value stocks by making the most of an investment strategy known as Dogs of the Dow.

Per this strategy, investors should purchase the top ten stocks in terms of dividend yield on the Dow Jones at the start of each year. They should also make sure to adjust this strategy each year. 

How Can You Spot a Value Stock?

We’ve already mentioned the main value stock characteristics: a value stock will have an incredibly low price compared to how well the company is doing,  as investors view the business as unfavorable in the current market. Usually, a value stock will boast an equity price beneath the stock prices of businesses operating in a similar market.

Value stocks can also sit within an industry that trades at a lower price when compared to the broader market. 

Publicity of a negative nature concerning legal issues or unsatisfactory earning reports are often indicators of a stock with a low value on the market. This is because the market is going to have a negative view of the business’s long-term prospects. 

A value stock will typically be from a mature business that has a stable dividend issuance that is temporarily encountering adverse events. Nevertheless, businesses that have recently issued equities also have the potential for a high value increase down the line, as many investors might not know about them yet.

Less Volatility and Risk Associated With Value Investing

One of the main reasons value investing is so popular with investors is that there is much less volatility and risk involved compared with the majority of short-term investment options available today.

As you are not purchasing stocks today with the aim of selling them tomorrow, you do not need to get caught up in the day-to-day whirlwind of price fluctuations in the market. Moreover, you do not need to spend your time monitoring the performance of your numerous stock holdings, as that performance revolves around a long-range strategy.

Moreover, going down the route of investing over the long-term is going to assist you in lowering risk in your stock portfolio, as attempting to time the profitable purchasing and selling of stocks over a short-term period is one of the greatest contributors to losses as an investor. 

The hold and purchase strategy linked with value investing enables you to avoid possible timing errors, as most of these happen due to emotional and hasty decisions, which are prompted by ever-changing events in the market. 

Tips on Investing in Value Company Stocks

Investing in company stocks and shares is something that many people are interested in. We have all heard the stories about people that bought a minuscule stake in Facebook, only to find that it is now worth millions. We all hope to invest in the next Facebook or the newest Microsoft or Apple. Of course, while we cannot guarantee that this will be the case, there are some ways you can give yourself a better chance of investing successfully. So, let’s take a look at the golden rules of investing in stocks and shares:

  • Know what you want to achieve – A lot of people make the mistake of diving headfirst without even knowing how to value stocks or what they want to achieve. Ask yourself, why are you investing? How much money do you want to make? What are your long-term goals? How much do you need to make to secure your future? Everyone’s investment journey is different, and you need to be clear about what you are hoping to gain from your investment in stocks and shares.
  • Understand what type of investor you are – Another important step you need to take when investing in stocks and shares is determining what type of investor you are. What is your investment style? You need to work this out before you begin to make sure you go down the right path. This includes analyzing your attitude to risk, as well as determining whether you prefer old-fashioned fundamental analysis or whether you are technically orientated, and so analyzing charts would be better suited to you.
  • Differentiate between big and small companies – There are pros and cons associated with both small and big businesses. You need to understand this to determine the best valued stocks and which route to take. Investing in BA Boeing stock may seem tempting because it is a big brand, so you assume it will be performing well. However, this does not always translate into the best investment opportunity, especially when, say, a global COVID-19 epidemic grounds most flights for months. The big blue-chip names listed on the main FTSE 100 index appear to be reliable and steady, however, this often means that there is limited potential for them to surprise or grow meaningfully. On the other hand, smaller businesses can fly under the radar, which means you could end up with a higher share price than the market anticipates. Nonetheless, this also means they are a lot riskier, so it is all about choosing what is suitable for you.
  • Spread your risk – Last but not least, diversification is a must for any person that invests in stocks and shares. Putting all of your cash into one business can work out spectacularly well but also fail spectacularly. Either way,  it is incredibly, incredibly risky. Diversifying your portfolio helps spread this risk. You can reduce your exposure to market risk by spreading your money across numerous investments. 

Worst Mistakes You Can Make When Investing in Company Stocks

The concept of making money work for you by investing is very appealing. However, it is also something that needs to be approached with caution. Many people have lost a lot of money by diving in headfirst. To ensure this does not happen, read on to discover some of the common investment mistakes you need to avoid.

Not doing enough research

This is a mistake that a lot of new investors make because they are so eager to start making money. However, if you begin investing without having researched the market thoroughly, you will likely lose money very quickly. There are lots of different investments, from property to stocks, and you have your work cut out for you working out the best options.

Being fooled by low prices

Just because something is available at a low price does not mean it will be a good investment. Investment is all about finding value. A high-priced stock may offer more value than a stock priced low because of the prospective return. You should never make an investment decision based on price alone.

Putting all of your eggs in one basket

Stock diversification is always good, especially when it comes to risky investments. If you lose money on one investment, it’s not the end of the world if you have a diversified portfolio.

However, if you only put money into one stock, you are at serious risk of extreme price movements and volatility of your investment.

Not considering your own risk aversion

Everyone has different attitudes to risk, and this is something you need to think about carefully when embarking on your investment journey. Someone else may be comfortable with high-risk investments, but if you are not, don’t push yourself.

Never lose sight of your own tolerance to risk so as to not turn investments into more stress than they are worth.

Gambling

Last but not least, don’t confuse speculation or gambling with investment. This is where a lot of people go wrong. You are not investing wisely if you blindly pick a stock or act on a “hot tip” without knowing what you are getting yourself into. You need to make an informed decision and be prepared to stick with it for a while.

Final Words on Investing in Value Stocks

So there you have it: an easy value stock definition and some tips about value stocks and investments in general - enough to get you started. We hope that this has helped you get a better understanding of where the best opportunities lie when it comes to investing in company stocks.

Value stocks are not easy to find, but they can be incredibly profitable. 

As is the case with any investment, though, make sure you do not rush headlong into the process. You need to conduct due diligence and understand the market before you part with your hard-earned cash.

You may even want to consider using the services of a financial advisor to help you in terms of planning your investment portfolio. 

FAQ

What is an example of a value stock?

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We gave some examples of value stocks in our article, but here it is in simple terms: a value stock is a stock with a price that is unusually low compared to the financial performance of the business it belongs to. This performance is measured by fundamentals like cash flow, earnings, dividends, revenue, and assets.

What does it mean to buy value stocks?

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Value investing is the art of purchasing stocks that trade at a much lower price than their intrinsic value. Value investors search for businesses using valuation metrics to find stocks that might potentially skyrocket in value in the future.

Why do people buy value stocks?

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The aim of investing in value stocks is to look for businesses trading at a discount compared to their intrinsic value. The gamble here is that the company will be able to outperform its current stock market value significantly if given enough time. If you can find a stock that is available at a lower value than it really should be, you will likely see a return on your investment over time. However, the trouble is that finding these stocks is a lot easier said than done.

Do value companies pay dividends?

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Most companies do pay dividends on their profits. In fact, it is not unusual for value stocks to pay higher dividends purely because their companies are viewed as mature businesses. However, this is not always the case.

Is Warren Buffett a value investor?

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Yes, in fact, he is widely thought of as the best value investor in the world. He has long held the belief that you should only purchase stocks in businesses that have solid fundamentals, the potential for high earnings, and the possibility of continued growth.

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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