What Are Value Stocks?
Value stock refers to those investment securities that trade at lower prices regardless of their composition. Composition entails sales, dividends, and payouts among others. Their values are usually are underestimated so that by the time the investor decides to sell them off, they will have added some value. The other definitions of value stock that investors may be aware of are; an investment that represents a company that is always considered to be lowly priced, mostly because of limited growth prospects. The other definition which closely related to the above is; security sold by a company whose earnings are in sync with the economy and with the waning of that industry in which the company is based.
Concepts About Value Stocks
In addition to being undervalued, value stocks have characteristics that are attractive to many investors like high dividend yield, low price to book ratio as well as a low price to earnings ratio, which is directly derived from the ratio of the price and the returns. The concept behind the low value of the stocks is that some companies choose to trade for less than they are worth. Value stock investing was started a long time ago in early 1900. The concept attracted many investors, and it has expanded to become what it is today. It is deemed successful and has added value to the investment habits of many investors. There is a need, however, for investors to be on the lookout for the future performance of these securities because they are bound to be affected by changing market conditions.
How to Value Stocks
Stocks are categorized by their differing benefits, returns, and risk capacity. Buying them for the first time is not an easy affair. People need guidelines on how to value and choose stocks. Many times, what you choose to buy is a reflection of who you are and what your mental processes are like.
An optimistic person is likely to go for growth stocks for example. These are investments that are likely to increase sales by at least 15% within one year. Someone who has a lot of patience may choose to go for value stocks, which are believed to be able to beat all unfavorable market conditions. Well, these are just two of the three major categories that investors may choose from. The third category is that of income stocks, which is the most common among many people. Investment in this category is pure to get returns on the investment.
Pricing of stocks is a process that is mostly based on ratios. The ratios try to compare the relationship between prices of an investment and the company’s index. Different ratios can be used, but the most common one is the price to earnings ratio. The price is divided by the return per share over a period of 12 months.
The other ratio that is used is the price to sale ratio, which is the price divided by the number of sales per share over a period of 12 months. The price to book ratio is also used to determine the price. It is also called the book value and puts into consideration the assets and liabilities of a company. The ratio is mostly used by value investors.
How to Pick Value Stocks
The common mistakes that a lot of investors make is chasing stocks that have been successful or have made big moves before investing in them. A safer investment with much more growth potential while limiting losses is investing in value stocks. There are a few things you should look for before investing.
1. Worst Performing Industry in the Past Year – If you look at yearly winner and loser charts there is a direct correlation between the losing stocks from the previous years increasing the following year and the exact opposite for the majority of winning industries. This is not without a reason since the profits have already been made in the winning sectors while the losers have been battered down so low they have nowhere to go but up. The conclusion is to buy the worst performing sector of stocks from the past year.
2. Out of Favor Industry – A prime example of this is the healthcare debate which in the last few years has battered healthcare stocks. Many big pharma stocks are at the lowest values in their history and have nowhere to go but up since the national health care problems are already priced into the stocks. The conclusion is to buy stocks that have potential problems already discounted in their share price.
3. Close-End Funds – Many close-end mutual funds trade directly on the stock exchange through their shares. The major difference between open-ended mutual funds and closed-end mutual funds is that the value of closed-end mutual funds trades many times at a discount to their actual value.
Buying value stocks are the best way to get great stock returns without the added risk that growth stocks command.