What is a Value Stock? How to Identify one?
What is/How to Identify a Value Stock?
There aren’t any ultimate indicators or the thumb rule of identifying value socks, but following are the major parameters that can be used to focus and short list value stocks list: –
- Low Price-to-Earnings (PE) Ratio
- A stock which is trading at below average of all the other stocks in that category, then that stock is called as a Low PE ratio stock
- PE ratio is nothing what price an investor is paying for 1 rupee of earning. For example, if a stock has a PE ratio of 20, it mean that for earning 1 rupee the investor is willing to pay 20 rupees
- PSU Bank stocks are generally low PE ratio stocks (not saying that they are value stocks). For example, suppose private banks are having PE ratio of 25-30 and PSU banks are having PE ratio between 8-12. This would mean that market is paying lesser money for PSU bank stocks compared to private bank stocks
- So, if a stock has low PE ratio then it can be said that is a greatly valued stock, but one should also look at other parameter like business performance, etc. along with it
- Low Price-to-Book (P/B) Ratio
- P/B ratio compares the current market price of the share of a company with its book value
- Let’s say that a company gets liquidated and its PB is 1. Then it would mean that one will at least get back the current value of whatever invested
- Generally, value stocks trade at lower P/B ratio, ranging between 1 to 2
- High Dividend Yield
- A company will give high dividend yields when the company doesn’t have any growth potential ideas with them and they don’t want to retain whatever surplus money they have or profits they are earning. They think that it is better to give that money to investors rather than re-invest
- High dividend yield means market feels that the company doesn’t have many great ideas for business and that is why they are distributing dividend to their investors
These are the basic thumb rule with the help of which one can identify or at least shortlist the first list of value stocks.
Suggestions for Investors: –
SEBI has introduced new mutual fund categorization and with that a Value/Contra investment strategy in equity oriented mutual funds. Investors can check few mutual fund portfolios and have a look at the average PE ratio, average P/B ratio and dividend yields of that portfolio to understand and identify value stocks:
- ICICI Pru Value Discovery Fund
- Aditya Birla Sun Life Pure Value Fund (more focused on small and mid cap and shouldn’t be compared with Nifty or Sensex PE ratios and compare them with small and mid cap indices PE ratio)
- Invesco Contra (Contra Strategy)
For example, ICICI Pru Value Discovery Fund has an average PE ratio of 19. Average PE ratios of Nifty or Sensex are 21-22. Thus, the funds PE ratio is below the average PE ratio of the category. The P/B ratio of the fund is around 1.8, which as mentioned above is between 1 and 2.
We are not suggesting anyone to invest in these funds and are only mentioning these stocks for you to have look at their portfolios and understand what value stocks are and how to identify them.