Value Stock Investors Dig for Treasure

Value investors are certainly concerned about the future because that's where their payoff is, but they must start with the present value of the stock.

Growth investors are expecting things to happen soon with a stock's price and with the company's fundamentals.

As I discussed in a previous article on growth stocks, those investors are fixed on tomorrow.

Value investors start with today. They are looking for companies that the stock market has under-priced.

For some reason, the company is worth more today than the stock market is giving it credit for being worth.

Value investors mine data to look for companies that may be good investments. Here are several things they look for:

High dividend yield

Companies that are paying large dividends compared to their stock price will produce high dividend yields.

The dividend yield is calculated by dividing the annual dividend by the stock price.

For example, a company with an annual dividend of $1.50 and a stock price of $35 per share gives you a dividend yield of 4.3 percent (1.5 / 35 = 0.0428).

That's a tremendous return and may be an indication that the share price is lower than it should be.

More on dividend yield.

Low P/E Ratios

Values stocks will be found with low price earnings ratios, usually in the bottom 10 percent of all stocks in the same industry.

The P/E tells you what the market is willing to pay for the company's earnings and if that number is significantly lower than the rest of its industry group, it could be a value stock.

More on price earnings ratios.

Good Debt Ratios

Value companies often have a good debt profile, meaning they have no more debt than equity.

This is often expressed in the debt to equity ratios. The quick ratio and the current ratio both check the relationship of debts and assets.

Neither of these ratios should be over 1, meaning the company has more assets than debt.

More on debt.

Margin of Safety

An important part of value investing is the margin of safety. This is the room for error you give yourself to avoid paying too much for a value stock.

If you believe a stock should be priced at $30 per share based on your examination of the company's fundamentals, a margin of safety might be $26 per share.

If the stock is currently selling for $14 per share, you are in good shape, even with your margin of safety price.

However, if the stock is currently selling for $22 per share, you may not think this it is a great value buy.

Conclusion

This brief introduction to value investing was meant to introduce the topic. As you become more familiar with the concepts, you'll develop your own standards for what defines a value stock.