A stock that tends to trade lower than its fundamentals (dividends, earnings and sales) is considered a value stock or a “bargain.” To a value investor such a stock is considered undervalued. The characteristics of a value stock are high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio.
Investing in (buying) a value stock represents an attempt to capitalize (profit) from inefficiencies in the market based on the fact the price of the stock does not match the company’s actual performance.
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Growth Versus Value
Of all the ways to invest, the two most basic strategies involve buying either growth or value. Growth stocks are equities of companies with strong anticipated growth potential. Value stocks, as already noted, are stocks that are “on sale.”
A balanced portfolio will include both value and growth stocks – at least in normal times. There are times, however, when one type or the other seems to do better in the market. Under normal circumstances a value stock is considered riskier than a growth stock. Mostly this has to do with the skepticism the market has toward value stocks. After all, for a value stock to become profitable, the market must change its mind about that stock.
Changes In Attitude
The stock market is finicky and that is apparent currently as “uncool” value stocks are starting to become popular. The reason has to do with recent market declines and increased volatility, all following a nearly decade long bull market.
Because of this some analysts are suggesting investors rebalance portfolios away from growth-oriented stocks toward value-oriented ones. According to Barron’s, this includes stocks in the telecom and financial sectors.
Analysts and experts point to telecom as a sector that stands to benefit from corporate tax reform along with financials bringing up the rear. With market turmoil and investor anxiety, these sectors stand as value beacons in the night.
Choosing value over growth when the market is uncertain is seen as a smart move. Value stocks tend to be larger, more established companies. This makes them less risky and volatile at a time when risk and volatility are primary concerns. Bottom line: Value stocks tend to perform better in tough times.
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Keeping It Cool
As interest rates rise thanks to rising inflation, investors need to find calm in the midst of market turmoil. Experts know the best way to achieve calm is to tilt your portfolio toward value stocks. Investors value companies by calculating the present value of future earnings. This is accomplished by discounting those earnings back by using an interest rate based on government bond yields.
When the bond rate goes up, future earnings suddenly worth less now. Value stocks, which have more of their earnings weighted toward the near-term and suffer less. This means those stocks should outperform if bond yields rise.