Aniket PujariInvestment word of the day: For any investor, getting the most value from their investments is always a top priority. This is where understanding ‘value stocks’ becomes important.
What are value stocks?
Stocks considered undervalued in the market are called value stocks. The stock market’s reaction may not always accurately reflect a company’s fundamentals, so these stocks trade at a price lower than their true value. Investors put their money into these stocks with the expectation that the market will eventually realise its true value, causing prices to rise and earning them profits.
Why are stocks undervalued?
Factors such as short-term market volatility, sectoral decline, the market’s overreaction to certain news, management changes or restructuring of the company, and economic cycles are some reasons a stock may be undervalued.
How to find value stocks?
Value stocks aim to boost profits from stocks priced lower than their true worth or discounted price. To assess if a stock is undervalued, investors must first determine its true value, considering factors such as revenues, cash flow, net profit, market trends, business models, etc.
A few ways to check the true value of stocks are listed below:
Price-to-book ratio (P/B ratio)
The price-to-book value ratio, also known as the price-equity ratio, shows the relationship between a company’s market value per share and its book value, which is the difference between the assets and liabilities mentioned in the balance sheet. A low P/B ratio means the stock trades for less than its book value.
Price-to-earnings ratio (P/E ratio)
The price-to-earnings (P/E) ratio determines the current price of a company’s share in relation to its earnings per share (EPS). This ratio can be analysed for different periods— typically, a period of 12 months is considered. The P/E ratio can be determined by dividing the current market price of a share by earnings per share. A lower P/E indicates the stock is undervalued based on its earnings potential.
Price-to-sales ratio (P/S ratio)
The price-to-sales (P/S) ratio shows the relationship between a company’s market capitalisation and total sales or revenue. It shows the value investors pay for each rupee of sales. A low P/S ratio is often seen as an indicator that a stock may be undervalued, showing that the company is generating enough sales but has a relatively low stock price.
Sound financial health
Factors such as earnings, dividend yield, cash flow, and low debt, which reflect the company’s financial health, play a key role in identifying value stocks.
