We all want to find the next $MARA, the next Zoom, or the next parabolic runner that’s moving solely on the basis of Reddit hype and diamond hands that dumps the next day. Looking at you, $NAKD. That’s all well and good, but even the best investors know this to be a gambler’s game most of the time.
A good alternative to the high risk, high reward venture of growth investing is value plays, and it seems to finally be getting some shine again after a long stay in the dark. Value investing has been vying for a comeback lately after growth stocks have essentially dominated it for the last decade.
Perhaps one of the most famous value investors of all time is Benjamin Graham. Graham even wrote two books covering his strategies, oh and he also taught Warren Buffet for a while too.
So then why has this promising method seemingly fallen to the wayside?
Value investing is the less attractive, but oftentimes more reliable alternative to the flashy prospects of growth stocks most new investors are drawn to. It often involves buying stocks that no one is thinking about anymore, or that just seem downright boring at the time of purchase.
It's like a really good sale. You know how we fall prostrate to worship the retail gods every time Black Friday comes around just because H&M is having a 50% off sale? Well, the stock market does similar things, but way more than once a year.
Value investors seek to find undervalued plays that have mostly been beaten down due to the emotional nature of the stock markets. Market indexes have a way of dragging down entire sectors and exaggerating both gains and losses of stocks just because of public sentiment. The market is a social creature, but value investing seeks to prey on that.
Value plays are typically more well-established companies that have already matured beyond their growth period. They’ve already been through puberty, and a mid-life crisis of sorts has gotten them a bit down lately.
Finding undervalued plays is the name of the game here, and there are many ways to go about doing that. Investors will use a myriad of different metrics and even more qualitative indicators to try and sniff out a diamond in the rough. The goal here is to find the (albeit subjective) intrinsic value of a stock, which is calculated based on a number of things, like:
- P/E Ratio. Price to earnings ratio calculates the price of the stock relative to a company’s reported earnings. The average P/E ratio for the S&P 500 has historically been about 12-13, which means the price is trading at 12-13x earnings per share. A higher ratio is either indicative of an overvalued stock, or that investors are in anticipation of growth in the future. Value investors though, look for stocks with an undervalued P/E ratio.
- Free cash flow is king and another valuable data point to use. It's measured how much extra cash a company has after subtracting operating expenses, capital expenditures, and other relevant sources of capital drain. A business with a higher free cash flow is likely to have more money to invest in growth, pay off debt, and expand, making it a solid candidate for being undervalued.
- Debt to equity ratios, or D/E, are used to determine what the company's debt looks like in proportion to its assets. A lower debt to equity ratio shows that the business is using less debt to finance its assets, and is generally a good indicator of an undervalued stock depending on the price. This also varies from industry to industry, with some sectors having more fixed costs than others.
- Other relevant indicators to check as part of your due diligence: P/B Ratios, PEG Ratio, CROIC and more.
Our Take. We could go on for days about the endless opinions and strategies that can create a successful value investment strategy, but each investor should curate their own personalized method by juxtaposing their goals with their tolerance, and of course their own research.
📚 Take this bite-sized quiz to review fundamental analysis of stocks and the key metrics that can help you with your due diligence: