When it comes to buying stocks, there are typically two big-picture strategies you can choose from—growth investing or value investing.
The idea of growth investing largely speaks for itself. Simply put, you invest in companies growing their sales and profits at impressive rates.
But does that mean value investing involves companies that aren’t growing? And how is this strategy better or worse?
Value investing doesn’t mean you’re buying a stock that has zero growth. It just means that growth isn’t the main appeal. Instead, you’re investing in a company that is likely to be underpriced and overlooked when compared with its flashier rivals.
Maybe the value stock in question isn’t seeing massive expansion, but rather it delivers a predictable stream of earnings and pays consistent dividends as it hums along. Or maybe the company has been severely punished by Wall Street after falling on hard times, creating a bargain opportunity.
Or perhaps it’s just plain boring, like a publicly traded utility stock or a small, specialized chemical manufacturer, and nobody is even paying attention.
Whatever the case, value investing is usually about finding hidden gems rather than chasing flashy companies everyone else is talking about. The appeal isn’t popularity or future growth projections, but rather the current underlying value of that business.
How do I find the best value investments?
There is a host of big-name value investors on Wall Street who made names for themselves by looking for hidden gems. Just a few of the more prominent ones include Berkshire Hathaway chief Warren Buffett and economist Benjamin Graham, who many consider to be the father of value investing.
So what made these icons so successful, and how did they find the best stocks to buy for value investors?
- Debt-to-asset ratio. Value investing prioritizes companies that have modest debts backed by much more substantial assets. Not only does a low debt load provide stability, it also tends to prove that management is responsible and has restraint. Generally, a debt-to-asset ratio of 1 or less is very attractive as it means those debts are covered.
- Price-to-earnings (P/E) ratio. Bigger companies obviously have bigger profits. So it helps to normalize the raw numbers by breaking down those profits into earnings per share and then comparing them against the company’s current stock price. This allows for “apples-to-apples” comparisons between stocks.
- Dividend yield. Dividends are regular profit-sharing payments to shareholders. A company’s dividend yield takes the total payments you get over 12 months and presents that money as a percentage of your initial buy-in. As you can imagine, getting a piece of your investment back regularly is a very attractive proposition to many folks.
While growth investing may get all the attention, value investments can still deliver under the right circumstances.
