Overview
“Value” stocks are typically characterized by low price to earnings or “P/E” ratios (i.e., they are a bargain or inexpensive when compared to the P/E of the overall stock market). For example, American International Group (AIG) is considered a value stock with a P/E of about 13. Compare this to Google’s current P/E of around 47! What does that mean? Essentially, when we talk about the stock market, think of everything from the perspective of what will happen in the future. A P/E of 13 means that, historically, investors are willing to pay 13 dollars for 1 dollar of earnings in the future. The bottom line: the P/E ratio is a gauge of how expensive the stock is when compared to the market or other stocks. Similarly, value stocks are also characterized by a low price to book value ratio (or P/B ratio). Think of book value as simply all of the assets of a corporation minus everything the corporation “owes” (i.e., the company’s liabilities). Whatever is leftover is considered the “book” value of the company. The concept here is the same: value stocks tend to be inexpensive based on the P/B of the market or other stocks.
More Stability, Less Sex Appeal
Value stocks are generally assumed to be more stable stocks with less “exciting” earnings growth prospects. That is, while the company may be well run and have solid, conservative financials, most investors don’t believe the company will show blockbuster earnings growth moving forward. In addition, they are also usually considered to be less risky investments. However, it is important to maintain a critical eye as this is not always a valid assumption - sometimes a risky company with grim prospects can have a low P/E (i.e., the P/E is low because the market knows the company is going nowhere). Finally, one of the benefits of owning value stocks is that they usually issue a quarterly dividend as a return on investment for shareholders. This is an additional bonus which can help boost long term gains for investors.
Value Investing
The term value is also used to describe a type of investing style or approach. Individuals who specifically look for “bargain” stocks which trade for a price they believe is below what the stock is actually worth are considered value investors. The most successful investors in history tend to be very good at picking stocks this way. Warren Buffett (you’ve probably heard that name before) is one of the best value investors of all time. The secret to his success (which we all stand to benefit from) is to think of stock investing as investing for the long term in businesses - not as the practice of short term buying and selling, ups and downs, etc. In my opinion, this is truly the only way to be consistently successful in the markets.
Related Links: Growth Stocks, Dividend Stocks