Posted: March 20, 2014
Value investing: Simple strategies
It doesn't have to be dauntingThomas Alley
The PEG ratio (P/E ratio divided by projected annual earnings growth rate) is a widely used value indicator that also factors in earnings growth. A low ratio relative to its peers indicates that the stock may be undervalued.
Another commonly used measure is to look at where the stock price stands within its price range over the past year. Although, by itself, it does not mean the stock is over or under valued, it can be helpful in gauging the overall price trend.
The Realities of Value Investing
As an overall investing strategy, value investing has had a varied track record of performance. In comparison to a growth investing strategy, value has outperformed in only 10 of the past 25 calendar years. Value stocks did outperform growth in each of the six years from 2001-2006, and again in 2012 and 2013 (through September 30). But growth stocks outperformed value stocks each year from 2007-2011.
Growth Versus Value—Historical Comparison
Both growth and value stocks have taken turns leading and lagging one another during different markets and economic conditions.
Value investing typically requires a long-term commitment. The gains to be realized from investing in an undervalued company can take years to materialize. A ten or more year holding period is not uncommon. Likewise, cyclical shifts that favor a particular industry or sector can take years to occur. It may take a long time for undervalued stocks within these areas to realize any gains from sector rotation.
It’s also important to keep in mind that buying undervalued stocks is inherently risky. Stocks with low valuations tend to be low for a reason. They may be experiencing financial difficulties, management problems, regulatory challenges or any number of issues that represent legitimate reasons for avoiding the stock. What’s more, it is easy to mistake a market downturn for a value buying opportunity. Just because a company’s stock price or P/E is heading downward does not mean that it is undervalued.
That said, a value investing strategy can be lucrative if done right. Just ask Warren Buffet. The key is applying a thorough review of all prospective issues and a consistent strategy. But it’s not easy. It takes a lot of time and effort to research companies, let alone value them. That’s why it’s best to work with a professional, who can help you identify undervalued companies or value funds.
Thomas Alley is Senior Vice President - Wealth Management with the Global Wealth Management Division of Morgan Stanley in the Denver Tech Center. He can be reached at 303-925-9705 or firstname.lastname@example.org.