Value investing is an investment strategy.

Value investing is an investment strategy.

The Appeal of Value Investing vs Growth Investing

General Electric

When it comes to investing, there are typically two big-picture strategies you can choose from – growth or value. The two approaches have their own merits, and understanding the difference can help you make more informed investment decisions. While growth investing focuses on companies with impressive sales and profit growth, value investing revolves around finding hidden gems that may be overlooked or undervalued by the market. This article explores the concept of value investing, provides an example, and offers insights on how to find the best value investments.

What is Value Investing?

Value investing doesn’t imply investing in companies with zero growth potential. Rather, it involves investing in companies that may be underpriced or overshadowed when compared to their flashier counterparts. These companies may not be experiencing explosive expansion, but they offer stability, predictable earnings, and potentially attractive dividends. Value stocks can come from a variety of sectors, including utilities and specialized industries. The focus is on the current underlying value of the business, not popularity or future growth projections.

An Example of Value Investment: General Electric

To illustrate the concept of value investing, let’s examine the iconic industrial stock, General Electric (GE). Although GE is not in a growth phase, its stock saw a significant surge of over 70% from January 1 to August 1 of 2023. This growth indicates that investors recognize the underlying value of the company, even if it is less dominant than it was in the past.

Wall Street had been excessively negative on GE due to a few challenging years, resulting in overselling of the stock. However, the company has quietly executed a multiyear turnaround plan and made strategic changes to cut costs significantly. Despite not being a booming growth stock, GE’s undervalued status presented an opportunity for investors.

Finding the Best Value Investments

Identifying the best value investments requires a careful evaluation of various financial metrics. Influential value investors such as Warren Buffett, chairman of Berkshire Hathaway (BRK.B), and Benjamin Graham, considered the father of value investing, have successfully employed specific criteria in their investment strategies. Here are a few metrics value investors closely monitor:

  1. Debt-to-asset ratio: Value investors prefer companies with modest debts and substantial assets. A low debt load signals stability and responsible management. Generally, a debt-to-asset ratio of 1 or less is considered attractive.

  2. Price-to-earnings (P/E) ratio: Comparing a company’s earnings per share to its stock price provides insights into its valuation. By normalizing profits, the P/E ratio allows for “apples to apples” comparisons. Industry groups may have different average P/E ratios, but the S&P 500’s current average is about 25.

  3. Dividend yield: Dividends are regular profit-sharing payments to shareholders. Dividend yield represents the total dividend payments over 12 months as a percentage of the initial investment. This metric is appealing to many investors seeking regular returns.

While these metrics are a starting point, there are many other financial indicators value investors consider. Mastering these concepts can be valuable when incorporating value investing strategies into a well-rounded investment portfolio.

The Power of Value Investing

Often overshadowed by the allure of growth investing, value investing still holds significant potential for investors. By recognizing companies with hidden value, undervalued stocks can provide opportunities for profit and income through dividends. Understanding the principles of value investing and conducting thorough research can lead to successful investment choices in the long run.