Information to Consider for Value Stock Investments - dummies

Information to Consider for Value Stock Investments

By Paul Mladjenovic

In your investment decisions, when you look at purchasing stock in a company from a value-oriented perspective, here are some of the most important items to consider:

  • The balance sheet, to figure out the company’s net worth: A value investor doesn’t buy a company’s stock because it’s cheap; she buys it because it’s undervalued (the company is worth more than the price its stock reflects — its market value is as close as possible to its book value).

  • The income statement, to figure out the company’s profitability: A company may be undervalued from a simple comparison of the book value and the market value, but that doesn’t mean it’s a screaming buy.

    For example, what if you find out that a company is in trouble and losing money this year? Do you buy its stock then? No, you don’t. Why invest in the stock of a losing company? (If you do, you aren’t investing — you’re gambling or speculating.) The heart of a firm’s value, besides its net worth, is its ability to generate profit.

  • Ratios that let you analyze just how well (or not so well) the company is doing: Value investors basically look for a bargain. That being the case, they generally don’t look at companies that everyone is talking about, because by that point, the stock of those companies ceases to be a bargain.

    The value investor searches for a stock that will eventually be discovered by the market and then watches as the stock price goes up. But before you bother digging into the fundamentals to find that bargain stock, first make sure that the company is making money.

The more ways that you can look at a company and see value, the better.

  • Examine the P/E ratio. The first thing to look at is the P/E ratio. Does the company have one? (This question may sound dumb, but if the company’s losing money, it may not have one.) Does the P/E ratio look reasonable, or is it in triple-digit, nosebleed territory?

  • Check out the debt load. Next, look at the company’s debt load (the total amount of liabilities). Is it less than the company’s equity? Are sales healthy and increasing from the prior year? Does the firm compare favorably in these categories versus other companies in the same industry?

  • Think in terms of 10s. Simplicity is best. You’ll notice that the number 10 comes up frequently in measuring a company’s performance, juxtaposing all the numbers that you need to be aware of. If net income is rising by 10 percent or more, that’s fine.

    If the company is in the top 10 percent of its industry, that’s great. If the industry is growing by 10 percent or better (sales and so on), that’s terrific. If sales are up 10 percent or more from the prior year, that’s wonderful.

    A great company doesn’t have to have all these things going for it, but it should have as many of these things happening as possible to ensure greater potential success.

Does every company/industry have to neatly fit these criteria? No, of course not. But it doesn’t hurt you to be as picky as possible. You need to find only a handful of stocks from thousands of choices.

Value investors can find thousands of companies that have value, but they can probably buy only a handful at a truly good price. The number of stocks that can be bought at a good price is relative to the market.

In mature bull markets (markets in a prolonged period of rising prices), a good price is hard to find because most stocks have probably seen significant price increases, but in bear markets (markets in a prolonged period of falling prices), good companies at bargain prices are easier to come by.