More on value stocks and value investing
Published:Wednesday | May 4, 2011 | 12:00 AM
As we said last week, 'value investors' actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company's long-term fundamentals.
The result is an opportunity for value investors to profit by buying when the price is deflated.
Typically, value investors select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields. A value stock is typically defined as a stock that tends to trade at a lower price relative to its fundamentals - that is, dividends, earnings, sales, et cetera - and thus considered undervalued by a value investor.
Common characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio.
The big challenge for value investors is to identify true value stocks. Two investors can be given the exact same information and place a different value on a company. For this reason, another central concept to value investing is that of 'margin of safety'. This just means that you buy at a big enough discount to allow some room for error in your estimation of value.