Value investors want to buy stocks for less than they're worth. If you could buy $100 bills for $80, wouldn't you do so as often as possible? That is pretty much a great buy meaning.
Here's an overview of value stocks, which is frequently associated with great buys, including some key concepts and metrics that (aspiring) value investors should know.
Great Buy Meaning and What Are Value Stocks?
Most stocks are classified as either value stocks or growth stocks. Generally speaking, a value stock trades for a cheaper price than its financial performance and fundamentals suggest it’s worth. As such, great buy meaning simply means purchasing a value stock for the price that it is currently trading for in the market despite its undervalued nature. A growth stock is a stock in a company expected to deliver above-average returns compared to its industry peers or the overall stock market.
Some stocks have both attributes or fit in with average valuations or growth rates, so whETHer to call them value stocks depends on the number of pertinent characteristics they possess. Value stocks generally have the following characteristics:
- They typically are mature businesses.
- They have steady (but not spectacular) growth rates.
- They report relatively stable revenues and earnings.
- Most value stocks pay dividends, although this isn't a set-in-stone rule.
Some stocks easily fit into one category or the other. For example, package delivery giant FedEx FDX) is clearly a value stock that’s fallen out of favor with Wall Street due to some short-term challenges. Fast-moving Tesla (TSLA) is an obvious example of a growth stock. On the other hand, some stocks can fit into either category. For example, there's a case to be made either way for tech giants Apple (AAPL) and Microsoft (MSFT).
Regardless of the category of a stock, economic downturns present an opportunity for a value investor. The goal of value investing is to scoop up shares at a discount, and the best time to do so is when the entire stock market is on sale.
Value Investors Definition
Long-term investors can generally be classified into one of three groups:
- Value investors try to find stocks trading for less than their intrinsic value by applying fundamental analysis.
- Growth investors try to find stocks with the best long-term growth potential relative to their current valuations.
- Investors who take a blended approach do a little of each.
Warren Buffett is perhaps the best-known value investor of all time. From the point when he took control of Berkshire Hathaway in 1964 to the end of 2021, the S&P 500 has generated a total return of 30,209%. Berkshire's total return during the same period has been a staggering 3,641,613% (that's not a typo).
Although he isn't as well-known as Buffett, Benjamin Graham is often referred to as the father of modern value investing. His books, The Intelligent Investor and Securities Analysis, are must-reads for serious value investors; Graham also was Buffett's mentor.
How To Find Value Stocks
The point of value investing is to find companies trading at a discount to their intrinsic value, with the idea that they'll be likely to outperform the overall stock market over time. Unfortunately, finding stocks that are undervalued is easier said than done.
That said, here are three of the best metrics to keep in your toolkit as you search for a bargain:
- P/E ratio: This is the best-known stock valuation metric – and for a good reason. The price-to-earnings, or P/E, ratio can be a very useful tool for comparing valuations of companies in the same industry. To calculate it, simply divide a company's stock price by its past 12 months of earnings.
- PEG ratio: This is similar to the P/E ratio but adjusts to level the playing field between companies that might be growing at slightly different rates (thus, PEG, or price-to-earnings-to-growth, ratio). By dividing a company's P/E ratio by its annualized earnings growth rate, you get a more apples-to-apples comparison between different businesses.
- Price-to-book (P/B) ratio: Think of the book value as what would theoretically be left if a company stopped operations and sold all its assets. Calculating a company's share price as a multiple of its book value can help identify undervalued opportunities, and many value investors specifically look for opportunities to buy stocks trading for less than their book value.
Closing Thoughts
While value stocks might not be quite as thrilling as their growth stock counterparts, it's important to realize that value stocks can have just as much long-term potential as growth stocks, if not more. After all, a $1,000 investment in Berkshire Hathaway at the beginning of 1965 would be worth more than $28 million today. Finding companies that trade for less than they are truly worth is a time-tested investment style that can pay off tremendously.
