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What is Value Investing? - Strategies & Examples!

December 07, 2020 15:00 UTC
Reading time: 19 minutes

Ever heard of Warren Buffett? The legendary, billionaire stock picker? If you have, then you have already been introduced to value investing and its king!

The art of picking stocks which appear to be trading at a significant discount to their intrinsic value has been at the heart of many investing strategies for professional and retail value investors over the past few years.

However, since the coronavirus pandemic of 2020, there have been record inflows into value based investing strategies - a trend that is likely to continue for the next decade, according to some analysts.

If you do not want to miss out on this unique shift in the market, then keep on reading! ▼▼▼

Value Investing

In this article, you will learn:

✅ A value investing definition used to find long-term and massively undervalued companies.

✅ The value investing strategy used by billionaire investors like Warren Buffett and large portfolio fund managers.

✅ The best value investing stocks to bullet-proof your portfolio and capitalise on this unique shift happening in the market right now!

✅ How to become a value investor and access the best investing tools for active investing, as well as the best products like exchange traded funds (ETFs) for passive investing.

What is value investing?

The simplest value investing definition is the ability to find investments that represent good value for money, or in other words, for less than they are actually worth. In essence, the value investor aims to find a stock, bond, currency, property or commodity that is priced at a significant discount to its 'intrinsic' value.

This type of investing is mostly used in the stock market to invest in high-quality companies that are considered cheap on a historical valuation basis. The value investor's job is to find these companies and take a long-term view on its stock price, in the hope that other investors start to realise the stock's potential and then also start to invest.

But why would some companies be trading at a discount to what it is actually worth? There are many different reasons why this could be the case, let's have a look at a few.

▶️ Disappointing profits. When a company posts a disappointing profit, investors can often react emotionally causing a fall in the company's share price. This is especially true if there is a pattern emerging of lower profits.

▶️ A market crash. Sometimes, a 'black-swan' event can happen causing investors to flee the stock market for safe-haven assets or cash. The 2000 tech bubble, 2008 financial recession and 2020 coronavirus pandemic are just a few examples of stock market crashes.

▶️ A change in industry dynamics. Over time, consumer habits change and new political parties enforce new regulations. Changes like these can cause a huge change in industry dynamics causing investors to exit some industries, even though a company could still perform well in such an environment. Think about traditional car companies during the rise of the electric car industry.

▶️ Company-specific news. While publicly traded companies provide transparency by releasing financial statements and having them audited, fraud and a scandal can still be possible. Just think about the Enron scandal in 2001, Worldcom in 2002, AIG in 2004, Lehman Brothers in 2008, Tesco in 2014 and VW in 2015.

As you can see, it can be very easy for a high-quality company to fall victim to a shareholder exodus causing a decoupling between what the company is actually worth and where it is trading. Value investors aim to identify these companies and take a long-term view that the company will return back to its intrinsic, or fair value.

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Value based investing criteria

While some of the big themes listed in the previous section can help investors find undervalued stocks, many investors also use financial ratios in their research. Let's have a look at the top three financial ratios for value investing stocks.

✳️ #1 Price/Earnings ratio (P/E)

This financial ratio is by far the quickest and easiest way to work out if a company's share price is undervalued or not. The price/earnings ratio is simply the company's share price divided by its earnings per share (EPS) level. The ratio helps to compare the company's stock price to how much profit it is making.

While useful by itself, it is far more powerful to compare the price/earnings ratio of several companies in the same sector. For example, comparing the price/earnings ratio of Wal-Mart, Costco and other retailers can give you a good price/earnings ratio of the overall industry.

A low price/earnings ratio means that the company could be undervalued as it is saying the company's stock price is quite low relative to the profit the company is making.

✳️ #2 Price/Book ratio (P/B)

The price/book ratio measures a company's stock price against the company's book or accounts value. The ratio is calculated by dividing the company's share price by its book value which is the value of a company's assets minus liabilities divided by the total amount of shares in circulation.

This ratio helps investors to understand how much they would get if the company was liquidated. According to Benjamin Graham, the father of value investing and Warren Buffett's teacher, value investors should focus on stocks that have a market value two-thirds below the book value of the business.

✳️ #3 Dividend yield

The dividend yield shows the income that is paid out annually (dividends) as a percentage of its share price. If you didn't know already, many companies pay shareholders a portion of the profits every quarter, six-months or annual basis - which is known as dividend payouts.

This ratio is calculated by dividing the annual dividend by the current share price. A high dividend yield could mean a higher income for the investor. However, as the dividend yield moves in the opposite direction to a company's share price, further analysis of high dividend yield stocks would be needed.

For example, a high dividend yield means the stock price of the company would be low. Further research needs to be done on why the stock price is low. The key is to find high-quality companies with strong dividend yields. You can learn more about this in the ' Best Dividend Stocks for Income' article.

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Value investing in stocks

If you need further evidence of how a value based investing strategy performs over the long-term, simply look at the chart below from asset management company Schroders. It shows the cumulative return from high dividend yield stocks, low dividend yield stocks and a benchmark index.

Essentially, the chart shows that investing in the cheapest, or most undervalued parts of the market means that you could have potentially outperformed the lower-yielding stocks and the overall market from the period the analysis was done (1900 - 2010) within the top 100 UK stocks.

Value investing performance Schroders

Source: Schroders, 7 December 2020

Of course, for the everyday investor trawling through thousands of company financial statements and reports while analysing all the different ratios is a time-consuming process. This is why many investors choose a value investing strategy that is more passive in nature through the use of exchange traded funds (ETFs).

Value investing strategy using ETFs

Exchange traded funds (ETFs) are investment funds that aim to track the performance of a certain market, sector or industry. For example:

▶️ There are ETFs that track the performance of the stocks in different geographical regions that everyday investors may not have access to. The iShares MSCI South Korea ETF provides investors with exposure to the stock market of South Korea.

▶️ Some ETFs will track other industries or sub-sectors which could include traditional industries like agriculture. The PowerShares DB Agriculture Fund ETF provides investors exposure to futures contracts from commodities in the agricultural sector.

▶️ The most popular type of ETFs from institutional investors track variations of stock market indices. For example, the iShares S&P 500 Value ETF tracks the performance of all the stocks listed in the S&P 500 index that are considered undervalued.

In the last example above, iShares - a company from BlackRock - is the company that creates, maintains and manages the fund. They, and other fund providers, provide investors access to a range of different funds. The iShares S&P 500 Value ETF is designed to help investors gain exposure to value based investments without having to find the individual stocks themselves.

Value investing with iShares S&P 500 Value ETF

Source: iShares, 7 December 2020

The chart above shows the hypothetical growth of $10,000 invested from May 2000. While investors could choose to invest in the fund itself, some active investors may choose to look at the stocks that are held within the fund that are deemed to be undervalued. From December 2020, the fund held 390 stocks from the 500 listed in the S&P 500 index. The top 10 holdings are shown below:

Value investing with iShares S&P 500 Value ETF components

Source: iShares

All fund providers provide a factsheet to help investors understand more about the fund and how the selection is made. This is great for everyday investors to learn more about the rationale behind the stocks within a certain fund.

For example, the iShares S&P 500 Value ETF chooses its value stocks by concentrating on companies that are in mature industries and have higher dividend yields. One of the differences between value vs growth investing is that the growth funds are often invested in companies within newer industries, offering near-term capital appreciation.

The chart below shows how the value based ETF surged higher from the initial sell-off from the coronavirus pandemic period which started in February 2020. This is because this unique event helped to push high-quality companies in mature industries to extremely low prices. This would in turn have pushed the dividend yield ratios higher.

Value investing MT5

Source: Admiral Markets MetaTrader 5, #IVE, Daily - Data range: from 26 Jun 2019 to 4 Dec 2020, accessed on 4 Dec 2020. Please note: Past performance is not a reliable indicator of future results. Last five-year performance: 2019 = +28.62%, 2018 = -11.47%, 2017 = +12.68%, 2016 = +14.51%, 2015 = -5.59%.

In the price chart above of the iShares S&P 500 Value ETF, it is clear to see the rally higher from the lows after the sell-off in early 2020. However, in this instance, the overall S&P 500 stock market index raced towards its all-time high price level, leaving the value based ETF underperforming.

It is important to remember that value investors like Benjamin Graham and Warren Buffett take very long-term views. Many retail investors tend to be emotional and come out too early or look for quick gains and are often left disappointed. The art of value investing is having patience which should be no problem for the passive investor.

How to start value investing

Once you have downloaded your FREE MetaTrader 5 trading platform provided by Admiral Markets you can search for different Value ETFs, directly from the platform. To do so follow these simple steps:

1. Open your free MetaTrader 5 trading platform.

2. Open the Market Watch window from the View tab in the top menu.

3. Right-click in the Market Watch and select Symbols.

4. Type in 'value' in the search box which will provide a list of instruments with this word in its name, as shown below:

Value investing MT5 symbols

5. To place a trade, simply drag the symbol from the Market Watch window onto the chart.

6. Right-click and select Trading and New Order. A ticket will open to input your trade details!

If you are interested in learning how to invest and why dividend stocks are the go-to choice for income-based investors then watch the video below! In this 46-minute video, a professional trader talks through what dividend stocks are and the key metrics to identify them.

Value investing stocks for 2021 and beyond!

Due to the coronavirus pandemic of 2020, many stocks were suddenly trading at huge discounts as investors panicked and sold their holdings. However, as a coronavirus vaccine became more likely towards the end of the year, the great 'sector rotation' started to take place.

This is where investors started to move back into value stocks from growth stocks. It is a trend that some analysts believe could go on for the next decade as macroeconomic trends change. The criteria for choosing the best value stocks may differ for each value investor but the basics should include, some of the following:

☑️ High-quality, well-known company brand
☑️ Strong dividend yield
☑️ Trading at discount to S&P 500 earnings
☑️ Strong sector fundamentals

On this basis, two value stocks stand out from the crowd for 2021 and beyond. Let's take a look!

✴️ #1 AbbVie Inc. (ABBV)

AbbVie is a US-based biopharmaceutical company that was founded in 2013 after a spin-off from Abbott Laboratories. The company employed more than 30,000 people globally and provides products in more than 170 countries.

The company focus on immunology, oncology, virology and neuroscience-based drugs. Some of its blockbusters include Humira which helped the company net $18.8 billion in sales in its first year as a publicly-traded company. But while AbbVie has more than $30 billion in revenue, it has also had its fair share of lawsuits related to some of its drugs.

This is one reason investors have shunned the company and why the company trades with a high-dividend yield. In fact, the biopharmaceutical company has raised its dividend for 48 consecutive years making it a strong contender for a value play - especially as the stock is not trading at its all-time high level yet.

Value Investing AbbVie

Source: Admiral Markets MetaTrader 5, ABBV, Monthly - Data range: from 1 Dec 2012 to 7 Dec 2020, accessed on 7 Dec 2020 at 10:00 am GMT. Please note: Past performance is not a reliable indicator of future results.

In the long-term, monthly price chart of AbbVie's share price above, it is clear to see the uptrend that has developed since 2012 has been quite choppy with some significant declines between 2017 and 2019. The fall from its all-time high price level of around $125 down to 2019 and 2020 multi-year low of around $63 is significant.

However, since this low, the company's share price has benefitted from a huge rotation back into healthcare and biopharmaceutical stocks which were in demand after the coronavirus pandemic in early 2020. With the stock is trading well below its all-time price level, offering a high dividend yield of more than 5% (at the time of writing) and only trading at roughly 8.4 times expected earnings there are some good long-term fundamentals. The S&P 500 stock market index was trading at roughly 21 times future earnings at the end of 2020.

✴️ #2 Jonhson & Johnson (JNJ)

Johnson & Johnson is a US-based healthcare company that was founded in 1886, employing more than 130,000 people in more than 175 countries. Most of its consumer products are well-known brands and include Neutrogena, Band-Aid, Listerine, Aveeno, Benadryl and more. The company also develops medical devices and pharmaceutical products.

While the company has worldwide revenues of more than $85 billion its share-price was dogged with lawsuits related to its baby powder allegedly causing cancer. The company has now discontinued the product due to declining demand helping to lift the share price, offering a stable dividend yield of more than 2.5% (at the time of writing).

Value Investing Johnson & Johnson

Source: Admiral Markets MetaTrader 5, JNJ, Monthly - Data range: from 1 Apr 2007 to 7 Dec 2020, accessed on 7 Dec 2020 at 11:00 am GMT. Please note: Past performance is not a reliable indicator of future results.

The long-term, monthly price chart of Johnson & Johnson's share price shows a decent uptrend that developed at the start of 2011 after a relatively choppy and sideways moving 2007 to 2011 period. While its share price rose from 2011 to 2017 it has since struggled between 2017 and 2020. This was largely due to the uncertainty around the impact of the baby powder lawsuit which started in 2017.

However, the share price has still remained resilient and continues to trade above its 50-period (red line) and 100-period (green line) exponential moving averages. This is suggesting that buyers still remain bullish on the future of the company's share price even after the obstacles it has faced over recent years, making it a strong value candidate.

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For example, below shows all the active technical trading events for Johnson and Johnson on 7 December 2020:

Value Investing Technical Indicator

A screenshot showing an example of searching 'Johnson & Johnson' in the Technical Insight™ indicator from the MetaTrader 5 Supreme Edition platform provided by Admiral Markets.

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Why start value investing with Admiral Markets?

✅ Invest with a well-established company authorised and regulated by the Financial Conduct Authority (FCA).

✅ Invest from the popular online trading platform MetaTrader for PC, Mac, Web, Android and iOS operating systems.

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✅ Open a Trade.MT5 account to trade via CFDs (Contracts for Difference) which will allow you to go long and short on an instrument to potentially profit from both rising and falling markets.

Did you know that one of the best ways to get started is to open a demo trading and investing account so you can test out all the services above completely FREE?

This account will also allow you to test your investing ideas and theories on thousands of different instruments and asset classes in a virtual environment until you are ready for a live account!

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About Admiral Markets

Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or recommendation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.