What are value stocks? Which stocks are amongst the most undervalued stocks?

Summary

• A value stock is perceived to trade at a lower price compared to its fundamentals.
• Value stocks trade at a price below the other stocks from the same industry group.
• Webjet and Origin can be considered as undervalued stock at present.

Value stocks are companies that trade at a lesser price compared to their fundamentals. In other words, value stocks trade below their actual worth, and thus, theoretically they can generate an improved return. This is the reason why value investors find them extremely attractive.

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Characteristics of value stocks

Value stocks are considered undervalued in the stock market. They have a high dividend yield and a low PE ratio. Besides, value stocks tend to have fewer fluctuations in prices during market highs and lows. Some other features include:

• They are priced lower compared to the broader market. People generally prefer value stocks as these are established firms that would bounce back in time as soon as the investors realise their true value.
• Value stocks trade at a price below their peer companies, falling within the same industry group.
• Value stocks are comparatively less risky but may also take time to turn around. Hence, they are considered suitable for long term investors. However, price fluctuations could be seen in value stocks more than growth stocks.

How to identify a value stock?

An investor looks at multiple approaches while picking a stock. A value investor generally invests in companies with steady profitability in the long term and regular dividend payments. Value investing focuses more on avoiding risk compared to growth investing.

This section will focus on three simple steps through which one can use to filter value stocks from the list of thousands of companies.

Step 1

In the first step, identify established companies available at a fair price. In the process, you can eliminate irrelevant stocks or fair companies available at a high price. The selection of a specific set of stocks can be done based on the following criteria:

• Return on equity (ROE) is more than 15%: ROE above 15% indicates that the Company is highly profitable and has a competitive advantage.
• Debt to equity ratio is less than 0.5: This indicates that the Company is less dependent on debt to fund its business and growth.
• Current ratio of more than 2: This ensures that the Company can pay short term obligation.

Step 2

From the shortlisted companies, you can pick the top three that have outperformed. For this, you can consider the following:

• Consistent high profitability.
• Low debt
• A sustainable competitive advantage.
• Competency of the Company’s management team.
• Understanding of the business.

Step 3

Estimate the intrinsic value of the Companies - In this process, we check whether the price is the right buying price or not for the three shortlisted companies. Identifying the right price would give a safety margin. Also, there would be less scope of downside risk even if the Company’s performance is not as projected.

Some of the ways to calculate the intrinsic value of a Company are:

• PE multiple
• Discounted cash flow model
• Return of equity valuation
• Dividend discount model
• Residual Income model

Two undervalued stocks on the ASX

Webjet Limited (ASX:WEB)

Webjet Limited provides a complete range of online travel booking services for flights, hotels, car hire, cruises, and tours. From January 2020 till 21 June 2021, the Company's shares have dropped from AU$9.78 to AU$5.18, ~47.3%. Due to the pandemic, the Company noted a considerable drop in its Total Transaction Value, Revenue and EBITDA in FY2021 compared to FY2020. WEB continues to focus on cost reduction initiatives across all its business.

• Webjet OTA profitability continues to improve, driven by brand strength as the leading OTA and scalability of the business model.
• WebBeds is committed to evolving as the leading global B2B provider.
• WEB has significant cash reserves, and its term deposit has extended to November 2023.

ALSO READ: Webjet Ltd. (ASX:WEB), Corporate Travel Management (ASX:CTD) incur the wrath of COVID-19; finances take a hit

Origin Energy (ASX:ORG)

Origin Energy is Australia's leading energy company engaged in exploration, generation and delivery of energy to more than 4 million customer accounts.

Origin shares also dropped significantly by ~45.6% from January 2020 till 21 June 2021. Recently, APA Group (ASX:APA) announced that it attained a Final Investment Decision with Origin Energy to expand transportation capacity on its East Coast Grid, connecting Queensland with southern markets by ~25%.

The new three-year gas transportation agreement with ORG would start from 1 January 2023. The deal would support ORG's energy requirements in the southern markets along with winter peak demand and before expected possible 2023 supply risks.

 In March 2021 quarter, Australia Pacific LNG Pty Limited  (APLNG) production declined by 4% on pcp. However, revenue improved by 7% from the prior quarter.

Electricity sales volume dropped 4% in March 2020 quarter. In addition, retail dropped 4% because of milder weather and lower usage.

As per Origin’s CEO Frank Calabria:

ALSO READ: Does Origin Energy pay dividends?