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Summary
- With the backdrop of COVID-19 and massive selloffs, value investing remained popular in 2020.
- Value investing involves buying shares of companies at a price lower than their intrinsic value.
- An investor can utilise a variety of financial tools for detecting the undervalued stocks.
The year 2020 offered a plethora of opportunities to benefit from discounted share prices of renowned companies as the stock market saw massive selloffs amid the uncertain pandemic situation. While it has been one of the most turbulent time, it certainly has scaled up the attractiveness of value investing for the years to come.
Notably, the investment strategy of value investing involves buying shares at a price lower than their intrinsic value. A market reaction to news can affect the trading price of a stock. However, the company’s analysis may highlight a relatively higher value of its fundamentals at the same time. The underestimated market price can be detected, generating a significant long-term return.
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With the pandemic scenario continuing to linger as 2021 begins, there lies a golden opportunity for utilising value investment options. Let us explore some ways that can be used for identifying value stocks.
Price-to-Earnings Ratio
The price-to-earnings (P/E) ratio is the ratio of a stock’s trading price to its earnings per share (EPS). Evaluating a stock price with respect to its earnings is used for assessing the relative value of a company and compare them with its industry peers. The higher value of P/E indicates that the market is attaching greater importance to a particular stock than its actual value. Contrarily, the stock with lower P/E ratio is considered undervalued.
For value investing, assuming other criteria remain the same, a stock with a P/E ratio of 10 is preferred over the one with ratio of 20.
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PEG Ratio
Price/Earnings-to-growth (PEG) ratio is the ratio of a stock’s price to the growth in its earnings per share. It has been significantly used stock valuation method for value investing. Notably, it provides a broad view of the company while also providing an overview of the trend relating to the company’s business performance and market movements.
PEG Ratio = (Price/EPS) ÷ EPS Growth
Compared to the simple P/E ratio, PEG gives a more comprehensive understanding of the company’s fundamentals. Notably, a lower PEG ratio is considered more attractive to value investors.
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Price-to-Book Ratio
Investors use price-to-book (P/B) ratio to assess the firm’s market value in relation to its book value. Book value is the carrying value, net of accumulated depreciation.
A lower P/B ratio highlights that the company’s worth is underestimated, and the stock is undervalued in the stock market.
Dividend Yield
Dividend focus has been one of the critical components of value investing, providing investors with a consistent revenue stream. Dividend yield is the ratio between the annual dividend paid on each share and the current share price of the company. It highlights the fraction of dividend received for each dollar invested.
Consistency in the dividend payment can highlight a company’s ability also to generate revenue. Often, mature companies tend to have a dividend yield on the higher side. A higher dividend yield can also be due to a decrease in the stock price.
