Investing in a bullish market is tricky as investors risk being easily lured by the promise of making quick money. While most stocks gain in value when the market inches towards an all-time high, experienced investors hunt for “value stocks” to put their money into. Since October last year, value stocks have been gaining a lot of traction and outperforming the growth stocks. Investing in value stocks is considered safer as they reflect relatively low volatility and experts advise beginners to focus on them to develop their understanding of the market.
What Are Value Stocks?
When investors try to cut their exposure but still want to remain invested, they try to identify stocks that are trading for less than their intrinsic or real value. These are stocks that investors basically believe are being undervalued. They are called value stocks. American economist and investor Benjamin Graham pioneered the method of ‘Value Investing' in the 1920s. And his method rings true to investors till date, with notable followers such as Warren Buffet and Peter Lynch.
How Value Investing Is Done?
This method can lead investors to develop substantial wealth over a long period of time but it requires them to analyse companies and their stocks with deft precision. Mostly, value investors show courage in going in the opposite direction to the market. The principle behind this method is: purchase when stocks are undervalued and sell when they reach their true or intrinsic value, or rise above it.
Value investors look for companies with long-term potential but temporary downtrends due to market biases. They depend on several parameters such as financial history, revenues and cash flows over the years, business model, profits and future profitability to determine whether a stock is performing below its capacity.
One of the tools that investors use to determine a value stock is its price-to-earnings (PE) ratio, which compares a business's earnings per share and the current market price. A higher PE ratio means investors are spending more for one rupee of the company's profit. They also consider the price-to-book (PB) ratio of a company before investing in them. A lower PB ratio indicates the stock is cheaper and discounted.
Another approach for value investing is finding companies with assets, like intellectual property or patents, not properly reflected in their balance sheets. This sometimes hides the true potential of a stock's performance but when the market conditions turn favourable this stock rises dramatically.