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What is Value Investing

Jeff Ramson - Stacks of pennies

Value investing is a stock trading strategy in which the investor seeks out and purchases stocks that are selling for less than what the investor believes they are actually worth. These are stocks that the investor believes are undervalued by the market. The hope is to make a nice profit once the company’s real worth is realized by other traders. Value investing is similar to when you were a kid shopping for candy. What did you look for? Probably which kind you could get the most of for the amount of money you had.

Stated most simply, value investors are bargain hunters. They don’t buy a stock because its earning are going up. True, the earning are sometimes going up, maybe rapidly, but that’s immaterial to a value investor’s stock-selection process. What’s really important is that by some measure the stock be cheap in relation to what its price ought to be- maybe cheap compared with its earnings now and in the future. One common yardstick for this is the price-earnings ratio or P/E. The price earnings ratio is determined by dividing the price per share by the earnings per share.

Another yardstick for determining whether a company is undervalued is the price-book ratio or P/B. If the P/B ratio is less than one, then the stock may be undervalued. If the P/B is over one, then the stock may be overvalued.

There isn’t a cookie-cutter way for determining whether a company is undervalued because their are so many factors that go into it. There also isn’t any correct way for analyzing the data. Two investors who are given the exact same information can come to two very different conclusions regarding the value of a company. Value investing is a very subjective strategy. One investor may place more weight on a company’s present assets and earnings while another will care more about future growth and cash flows.

Generally speaking, value investing is finding a good business that is run by smart people at a reasonably good price relative to its values today and five or more years from now. Value stocks have low P/E and P/B ratios. They are companies that have been overlooked on their journey to success, have fallen on hard times after more successful years, or are in a slump for any number of reasons. The hope is that the company is on a come up or comeback and the value investor purchases shares at the bottom of an uphill climb.

Jeff Ramson is the CEO of PCG Advisory Group and an authority within the Investor Relations industry.

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