Investing > Complete Guide to Value Stocks

Complete Guide to Value Stocks

 If you're serious about investing, you need to understand how value stocks work.

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Updated July 08, 2021

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

If you want to invest, you have one simple goal:

To grow your portfolio. 🌱

Whether you play it safe with bonds and low-volatility stocks or risk it all on options trading, you want to make money. Since everyone’s looking to make a better return, let’s talk about the strategy that has bolstered a 1,344,600% return rate since 1926.

In this article we will guide you through the world of value stocks, breaking down what they are, when to buy them, and how to avoid common pitfalls. Value investing is a great way for all kinds of investors to keep their portfolios growing. For nearly a century it has helped adept investors beat market averages—let’s see how it can help you.

Ready to learn more? Let’s go! 🚀

What you’ll learn
  • What are Value Stocks?
  • Example of a Value Stock
  • How to Find Value Stocks
  • When to Buy Value Stocks
  • When Not to Buy Value Stocks
  • Watch Out For Value Traps
  • How to Invest in Value Stocks
  • Balancing Your Account
  • Risks of Value Stocks
  • Value Stock Returns and Benefits
  • Famous Value Stock Investors
  • Get Started with a Broker

What are Value Stocks? 📈

When it comes to picking individual stocks, people wonder if it’s worth the hassle. But value stocks have a proven history of profitability—so what exactly are they?

Value stocks are companies that are trading for less than what they are worth. The true worth of a company may come from strong earnings or potential growth, and these are companies that have great prospects over the long term, but may be temporarily depressed in price due to current market conditions. 

Socks can trade at temporarily low prices for many reasons. The business may be dealing with an important lawsuit that will affect future profitability. They may have had negative publicity that is hurting the corporation’s image. Or maybe the management has changed and investors lack confidence in the new leadership.

Whatever the reason for the low price, investors use a set of metrics to compare these stocks to the rest of the industry—dedicated investors will sniff out when a value stock is below what it’s worth, and buy in. The reason investors are looking for these companies is because they can often return greater profits than the average growth of the market. 

Value stocks can generate such good returns because they can bounce back from temporary difficulties and exceed expected performance. The companies may have important patents or trademarks that make it hard for other companies to compete with them or the industry that the company works in may have high barriers to entry. All of these things are important to consider when looking for value stocks.

Example of a Value Stock 💡

Some investors still remember when Amazon stock dropped by roughly 33% in late 2018. This was caused by a mass selloff that followed Trump imposing tariffs on China—investors thought this would cripple Amazon’s business model. 

However, AMZN rallied completely in less than 5 months and reached its then all-time high soon after—now, the company is still doing well and growing. Since Amazon is a big, established company, and is generally considered a safe investment—owning its stock is profitable, especially if you can get it cheap.

Amazon Rally
Amazon rallying after 33% drop—perfect opportunity for value investors.

In this example, the company suffered no real problem, yet mass fear caused it’s price to drop—this was the ideal moment for value investors to jump in and buy the stock while it is undervalued. This might be a slightly extreme example, but still—if a company is doing well and will keep growing at its usual pace, buying it when it goes on sale makes perfect sense.

How to Find Value Stocks 🕵️‍♀️

The question every potential value investor wants to know is how do I find these companies. Although it may not be as easy as checking Reddit for the next meme stock 💎🙌, it can be pretty simple. 

Just remember, when it comes to value stocks, being first to the party counts. You need to be ahead of the pack in finding great companies that haven’t been overblown by other value investors.

In order to find a value stock, you have to know about a few metrics. You will use metrics such as the Price to Earnings Ratio, the PEG Ratio, and the debt to equity ratio to compare a company against the overall market and competitors within the same industry. All of these metrics can be easily viewed by using a stock screener.

Understanding the cash flow, return on assets, and the amount of debt a company is incurring is crucial. But arguably more important than any of that is understanding how these fundamentals are going to impact the price of the stock.

When to Buy Value Stocks 📅

You want to buy value stocks when the metrics indicate the asset is undervalued. This is going to be before hoards of people jump on and the price starts ticking up and up. It’s important to be independent of the way the majority of investors are thinking. As hard as it may be, many value investors have to find a way to kill their FOMO. 💀

You should try to buy value stocks when we enter a bear market and many assets are trading beneath their historical highs. You can also find value stocks at a good price when there is bad news about the company, such as underperforming on an earnings call. These can be indicators of worse things to come, but if you are confident in the company, it may just be a good time to buy the stock.

When Not to Buy Value Stocks ⚠️

You shouldn’t buy value stocks if you are just chasing a trend or following someone else’s advice. Lots of value stock investors will turn their nose up to other investors who follow the herd into questionable financial vehicles. The sad fact of the matter is that value investors do the same thing—they will follow other value investors into vehicles that they have no idea about.

You should not buy stocks just because someone told you to do so, but you also should avoid buying value stocks when they start reaching their true value. You aren’t a value investor when you are buying a company that metrics have indicated is no longer undervalued.

That’s not to say you aren’t entering the market at a good time. Many companies have pretty high price points and they can still be solid investments. These are often considered growth stocks, and they are very different from value stocks.

Another thing to consider is if the temporary depression of a value stock is actually a long-term depression. If a company shows no signs of life after a certain period, you may have found a dud. This happens in the stock market, and there may come a point when you should cut your losses and throw your cash in something that isn’t a corpse.

Watch Out For Value Traps 🧀

Value traps are a great example of a time when you should not buy a stock. These companies have all the outward aspects that appeal to value investors: Low PE ratios, good market saturation, and maybe even a great outlook for future profits. However, there is just something off about the company like this.

This could be little things, like the company being run by awful management. You should try avoiding companies that are being run by scammers. You can often find news about scammers simply by typing the names of senior leaders of a firm into Google and adding “scam” or “scandal” to your search.

Not only should you avoid bad management, but also companies who you think their long-term gains are inhibited by some other factor. This may be the direction that traditional oil companies are heading if they refuse to diversify into other energy sectors.

Tech Industry Value Traps 💾

The same danger is present with many tech startups. Every few months, a company with really revolutionary technology pops up and gets a ton of venture capital, driving its price to the stratosphere immediately after its IPO—so much so that you might get the idea you can catch a value stock before it gets big. 

There are companies that aren’t making profits, but are so “innovative” that you think they are going to perform like Apple or Amazon eventually. However, most of these are only valuable because of the initial hype, and most end up like WeWork, which is a startup that only made money for its founders and investors who sold their shares early on.

Then there is the other side of the coin. If a tech company is not innovating, it will lose its edge and get swallowed up by more creative competitors. In this case, a drop in stock price might not indicate that it’s time to buy, but that it is time to sell.

How to Invest in Value Stocks 🚀

Buying value stocks can be summed up in a few steps. But it can get complicated fast, so it’s better to have a roadmap which you can follow when approaching new investments.

Step One: The first step to investing in value stocks is doing your research. Try using a screener to break out stocks based on their high cash flow, dividend yield, low PE ratio, and good future expected earnings. You want to be discriminative about what stocks you select because there aren’t many undervalued companies.

Step Two: Once you’ve got your list of companies from the screener, then you are going to look into the companies in more detail. Try to find any information on past performance and scandals that have occurred. Make sure you understand the company, how they make money, and what their future profits will look like. In this step, you should narrow down your list to the top 10% of companies.

Step Three: Purchase the company and get ready to wait. Value stocks might not be the fastest and flashiest way to get rich but the key is to have patience—in time, your investments will grow.

So, you’ve found the right stock, you’ve done research to avoid a value trap, and you have a great stock broker, now it’s time to pull the trigger. But wait, how much of the stock should you buy, and at what time?

These questions can be tricky to answer and it will depend entirely on your investing style. In general, value investors are interested in the long-term performance of an asset. If you are learning to be a day trader or a swing trader, value stocks may not be the right choice for your portfolio. 

When it comes to stock picking, you will also need to determine how much of your portfolio you want to have tied to any one stock. Having a portfolio entirely devoted to one value stock that may or may not take off in a few years would be inadvisable.

Instead, try looking for a group of value stocks that you are confident in. Decide how much of your portfolio you are willing to risk on any one of those companies. Then, over time, adjust the amount you have invested in each one to match your goals. This is a sure way to keep a balanced and healthy account.

Balancing Your Account ⚖️

To keep an account balanced, you need to decide how much of your portfolio you want to keep in any one asset. This could be a dollar amount but is often a percentage of your overall account.

In the example below, we will look at an account that has only 4 stocks (not very diverse) and how these balances shift over time from their targets. Many advisors suggest that you allocate no more than 5% of your portfolio to one asset.

StocksStarting/Target DistributionYear 1 Growth
Stock 125%+9%
Stock 225%+25%
Stock 325%-4%
Stock 425%0%

When we reach the end of year one, the market has completely warped the composition of our portfolio. Instead of ¼ of our account being in each of our chosen stocks, we now have this:

StockEnd of Year 1 Distribution
Stock 125.35
Stock 229.01
Stock 322.33
Stock 423.26

To avoid having your portfolio roll too far off track, many investors will realize the gains from their higher-performing assets and buy into underperforming stocks. This is a good way to manage risk in your portfolio, but it also means you should be confident in your investing strategy and the assets you’ve chosen.

Risks of Value Stocks 📉

One of the major risks of value stocks is that you pick a company that is either a value trap or a company that will only lose money with time. Of course, this is the inevitable problem that we always have when it comes to investing.

The only counter to this is to be vigilant and learn to research thoroughly. Without keeping an eye on the companies you believe in, you could see your money dwindle and fade away into the vast abyss of the market. 👽

Value Stock Returns and Benefits 🔎

Value stocks have returned high profits again and again. Finding the right stock is crucial to obtaining these profits, but it happens all the time.

One famous value stock play comes from Berkshire Hathaway’s acquisition of AAPL which is worth roughly $50 billion in the firm’s portfolio. Since 2016 the company has been buying shares of AAPL and has netted more than 25% gains, well outpacing the market averages at that time.

Growth rates of Apple
Growth rates of Apple and the S&P 500 since 2016 compared. Image by TradingView.

On top of the increases in AAPL value over time, APPL has increased its dividend payout consistently for the past 8 years. Making the value play not only profitable, but also consistent.

Value Stocks During COVID-19 🦠

Keeping a cool head during a crisis is the best way to find stocks on deep discounts. Where there is panic, there is money to be made, and that’s how the hedge fund manager Bill Ackman made billions during the pandemic.

Value stocks are as relevant now as they have always been, although many people have opinions on whether we are seeing the ultimate demise of value investing, it’s unlikely that we are seeing them go away. Value stocks have been a good source of growth for a lot of investors, and the big companies that are considered value stocks haven’t been hit as hard as the rest of the economy during COVID-19.

Value Stocks in a Recession 🔻

Just like the pandemic, value stocks become especially great during a recession, but it can take some real grit to manage. You may see the market recede or flatline during a recession, and growth can be slow.

There’s no doubt that investing during a recession is no simple feat—but it’s absolutely possible, and profitable. If you are looking to bolster a portfolio with value stocks, recessions are helpful because the ability to receive returns is maximized by low costs.

Famous Value Stock Investors 📰

Everyone has heard of one of the most successful investors of all time, Warren Buffet. But did you know that he is an advocate of value investing? There are many other investors who have made significant returns with these strategies.

Bill Ackman – As the founder and CEO of Pershing Square Capital Management, Bill Ackman is estimated to be worth $2.5 billion by Forbes. He is famous for his style of angel and value investing.

Li Lu – Li Lu runs his own investment fund, Himalaya Capital Management, and is estimated by Forbes to be worth $800 million. Using value investing, Li Lu has beat average market returns despite only holding a few companies.

David Einhorn – A value investor and hedge fund manager, Forbes estimates that David Einhorn is worth $700 million. Although his firm has not performed optimally in recent years, before 2015 value investing led the way for incredible returns.

Conclusion

Value investing has its downsides, but the right investor who researches and follows through with their plan can beat the average. The best investors of all time have consistently made money with value investing—so why not try it?

Just watch out for those value traps. 🧀🐁

Value Stocks FAQs

  • Why Does the Value of a Share of Stock Depend on Dividends?

    The value of a share can depend on dividends because it is the way in which companies pay shareholders. Dividend payments can help improve the stability of stock, but they also lead to a decrease in the price of stock equal to the dollar amount of the dividend paid.

  • What Are Large-Cap Value Stocks?

    Large-cap stocks are generally categorized as companies that have over $10 billion in market capitalization. One famous large-cap stock is Apple, which is currently valued at over $2 trillion.

  • Are Value Stocks a Good Investment?

    Value stocks can be one of the best assets for investors. Solid returns have been proven time after time as value stocks often outperform the market average.

  • Do Value Stocks Outperform Growth Stocks?

    Value stocks can outperform growth stocks, but their performance is dependent on the time you are invested. Some value stocks may take years, or even decades, to reach their full maturation.

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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

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