Definition of Value Stocks

Based on the Oxford dictionary, value stocks are shares of a company with solid fundamentals that are priced below those of its peers, based on analysis of price/earnings ratio, yield, and other factors.

Based on Investopedia, value stocks are shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or sales, making it appealing to value investors.

My definition of value stocks is simple: they are shares of a company trading at a price substantially below its value based on a realistic forecast of its future cash flow projection.

Important Good Characteristics of Value Stocks

1. It cannot be a bad business

I am very wary of value traps.

A company is usually cheap for a reason.

If the company remains bad or they are bad, it will usually always be cheap, and it can get cheaper.

Source: Eastman Kodak

A good example is a company that all of us know, Eastman Kodak.

Rapid changing technology in the advances of digital cameras drove Kodak to an embarrassing bankruptcy in 2012.

Even though Kodak stock may look cheap at some point in time, because the business failed to innovate, the “Kodak moment” was no more. It was a bad business that did not turn around. 

2. They are under-appreciated

A company can be under-appreciated for a variety of reasons.

They could be smaller in market capitalization and not on the radar of many big funds.

Or it could be that the company is currently facing temporary problems that could be transitionary.

Either way, under-appreciated companies can be a potential value buy for the long-term – if their future is brighter than their past.

3. They are growing

Growth and value, in my view, are joined at the hips.

I would also like to see some growth when investing in value stocks.

The PEG (Price to earnings growth) ratio is a common metric comparing the company’s value to its growth.

If a company has a PEG below 1, it may be worth diving deeper into.

If a company has a PE ratio of 10, but its earnings are falling by over 50% a year, a “cheap” PE ratio of 10 could become a PE ratio of 20 in 1 year and 40 in 2 years.

4. Wonderful people run them

We want to own businesses that wonderful people run.

As inspired by Warren Buffett, we too should want management who can widen the moat of the business they run, to build enduring competitive advantage, making customers happy and taking care of costs.

Source: Netflix

Netflix has become so successful because they are run by wonderful CEO like Reed Hastings, who cofounded Netflix in 1995, which was also the same year he sold his first company, Pure Software.

Netflix’s culture encourages innovative thinking over efficiency and valuing people over process.

In Conclusion: Should We Invest Just Because It is A Value Stock?

No.

Turnarounds are rare.

Value stocks are usually cheap for a reason.

Be careful of value traps, which are companies that seem cheap based on traditional metrics such as the PE ratio, but they can get cheaper because the business results become worse and worse over time.

But if we can find that sweet spot of a company we understand deeply and, at the same time, has problems that are only temporary in nature or one that is nearing a positive inflection point, that could be the ideal value stock that we should be eyeing.

Disclosure:

I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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