Home' Trinidad and Tobago Guardian : April 27th 2014 Contents SBG18 ANALYSIS
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt APRIL 27 • 2014
Avalue investing approach
has long been used by
such successful and well-
known investors as Ben-
jamin Graham and War-
ren Buffet, who have
followed strategies that
help identify stocks that are undervalued and
offer upside potential.
Buy low, sell high. This simple adage sums
up the value investing philosophy. But in prac-
tice, value investing is far from simple. Done
right, it involves in-depth investigation of a
company's business, industry and competitors;
a valuation of its assets and cash flows; and
complex quantitative analyses of its financial
results and stock performance. For everyday
investors, a true value approach can be daunt-
Yet there are some simple strategies available
to those who wish to pursue the value approach
that can help them identify stocks that pose
Value investors look for stocks whose intrin-
sic value is greater than their current price.
They seek companies that have fallen out of
favour but still have good fundamentals. Value
stocks are considered bargain priced compared
with book value, replacement value or liqui-
dation value. Typically, value stocks are priced
much lower than stocks of similar companies
in the same industry. This lower price may
reflect investor reaction to recent company
problems, such as disappointing earnings, neg-
ative publicity or legal problems, all of which
may raise doubts about the companies' long-
term prospects. The value group may also
include stocks of new companies that have
yet to be recognised by investors.
Stocks that may be undervalued share two
critical qualities: strong fundamentals and
attractive valuation metrics.
Benjamin Graham, the father of value invest-
ing, advocated a disciplined approach for iden-
tifying stocks with value. Critical to this
approach is a familiarity with the business of
the company you are investing in. You should
be knowledgeable about what the company
sells, how it operates, what the competitive
environment is like, who manages it, and what
its threats, opportunities, strengths and weak-
A good place to start is with businesses or
industries you know or are interested in. Know-
ing a company's products, customers, com-
petitors and operating environment is essential
in identifying its intrinsic value, and the more
familiar you are with it, the better. Does the
company have some unique competitive edge?
Does it dominate its market? Is it in a sector
or industry poised for growth? These factors
can be key to future growth.
Next, narrow down the field by screening
for companies that have a history of strong
and consistent financial performance. Look
at short- and long-term trends in sales and
earnings, as well as cash flow. Also consider
the company's debt levels and cash position.
And if the stock pays dividends, look at yield
Financial characteristics that value investors
typically look for include:
• Strong balance sheets with little or no
• High coverage of fixed charges, debt service
and dividend payments
• Strong or improving operating margins
• Consistent growth in sales and earnings
• High return on equity or return on assets
relative to peers
A company's financial statements and an
analysis of its financial results can be found
in its annual report, or its SEC filings, which
are available through the SEC Web site.
A number of different valuation ratios
attempt to gauge a stock's "priciness" by look-
ing at the stock price as a proportion of its
earnings, sales or book value (equity). These
metrics can be used to compare the valuation
of different securities and help determine how
expensive a stock may be in comparison with
comparable issues. Typically, value stocks are
priced much lower than stocks of similar com-
panies in the same industry. So with each of
the following metrics, look for low values in
comparison to peers or industry averages.
The most widely used valuation metric is
the price-to-earnings (P/E) ratio. It is calculated
by dividing a company's closing price by its
historical or projected per-share earnings over
a specified period.
Note that P/E ratios will differ depending
upon what earnings are used. Often, analysts
use projected earnings to compute this ratio,
since stocks are traded on future expectations
rather than past results.
Similarly, the price-to-sales (P/S) ratio is
calculated by dividing a company's closing
price by its historical or projected sales. The
price-to-book (P/B) ratio represents the closing
price divided by the company's book value,
or common equity, per share.
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
Realities of value investing
As an overall investing strategy, value invest-
ing has had a varied track record of perform-
ance. 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
Growth vs value,
an 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 realised
from investing in an undervalued company
can take years to materialise. A ten or more
year holding period is not uncommon. Like-
wise, 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 realise any gains from
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 rep-
resent 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
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 pro-
fessional, who can help you identify under-
valued companies or value funds.
Article by Wealth Management Systems, Inc. and
provided courtesy of Morgan Stanley Financial Advisor.
Standard & Poor's Financial Services LLC ("S&P"),
which maintains the S&P500/BARRA and S&P
500/Citi Growth and Value indexes, is a subsidiary
of The McGraw-Hill Companies.
Equity Securities' prices may fluctuate in response
to specific situations for each company, industry,
market conditions, and general economic environ-
Value investing involves the risk that the market
may not recognise that securities are undervalued
and they may not appreciate as anticipated.
Companies paying dividends can reduce or cut
payouts at any time.
The securities discussed in this material may not
be suitable for all investors. The appropriateness of
a particular investment or strategy will depend on
an investor's individual circumstances and objectives.
The Trinidad Guardian engaged David Fox
to feature this article.
© 2013 Morgan Stanley Smith Barney
LLC. Member SIPC.
Simple strategies for finding value
DAVID H FOX
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