What Is a Value Stock?
Value stocks are stocks that typically trade at lower price-to-earnings (P/E) multiples. The P/E multiple or P/E ratio measures the share price compared to the annual net income per share earned by the company. The P/E ratio is equal to price divided by earnings per share.
How to Find Value Stocks
When learning how to find value stocks, you should consider several factors including P/E ratio, price compare to their peers, volatility, and dividends.
Here are some tips to look out for when investigating each factor to determine if your stock is a value stock:
- P/E ratio: value stocks tend to have lower P/E multiples than other stocks
- Price compared to their peers: Value investors look at where a company's peers are trading. Companies in the same sector often trade at similar P/E multiples unless there are reasons for some of them to trade at lower multiples than others. For example, companies that are going through some sort of transition might trade at a lower P/E multiple than their peers.
- Volatility: value stocks tend to less volatile than other stocks, although that is not always the case.
- Dividends: Many pay dividends, although not all do.
Tip: Value stocks are generally stocks of companies with lower expected growth which also trade at lower valuation multiples.
Investing in Value Funds
Outside of looking at individual stocks as a primary means of investing, you can also invest in a value-related exchange-traded fund, index fund, or other value funds like hedge funds that take a value investing approach. Investing in a fund that invests in value stocks will get you a diversified portfolio of value stocks, all in one place.
Some examples of value-focused funds are:
You could also invest in conglomerates that hold a multitude of value investments. One of the best-known ones is Berkshire Hathaway (BRK.A) (BRK.B), which is run by Warren Buffett, one of the greatest value investors of all time. Berkshire invests in many value stocks. However, if you do invest in a conglomerate company, you may want to consider some value ETFs or index funds as well for proper diversification.
Value vs. Growth Stocks
Value stocks are seen on the opposite spectrum to growth stocks. Value stocks generally have lower P/E multiples than growth stocks, and the businesses aren't usually growing as quickly. With growth stocks, the focus is on a rapid rate of sales growth and margin growth, while with value stocks, the focus is on low-growth businesses.
Additionally, theses for value stocks may take a long time to play out, requiring investors to be patient, while growth stocks are companies whose investment growth stories are playing out right now.
Are Value Stocks Risky?
One of the biggest risks with value stocks is that your thesis won't play out. Some companies may fail to execute on the turnaround plan that's intended to bring their P/E multiple or valuation in line with the multiples and valuations of their peers. Sometimes it may take an exceptionally long time for investors to notice that a company has a low P/E multiple compared to its peers, and there is always a chance that the broader market never does. A value stock that struggles despite having a low valuation multiple is often called a value trap.
Value stocks tend to outperform other stocks during times of economic distress or slowdown, so they may be more popular during downturns. However, they often fall out of favor during extreme bull markets like the one that lasted more than 10 years after the end of the Global Financial Crisis.
Conservative investors tend to gravitate toward value stocks more than aggressive investors. They don't like to take on the type of risk associated with growth stocks, which tend to have high P/E multiples.
Tip: Value stocks often outperform during an economic slowdown but underperform during bull markets.
Should You Invest In Value Stocks?
To decide whether you should invest in value stocks, you should think about the amount of risk you are willing to take on and where the market is in its current cycle. On one hand, stocks with high P/E multiples can be risky because it's unclear when investors will stop pushing them higher.
However, on the other, value stocks may underperform during bull markets. Many value-focused hedge funds struggled with lackluster returns during the bull market that lasted more than 10 years after the Global Financial Crisis.