For investors who are skittish about market ups and downs, value investing could help. Unlike growth investors, value investors don’t chase companies they think will experience rapid expansion. Instead, they focus on stocks they think are priced below their worth, buying them at a possible discount with the expectation the price will increase in the future. Here’s what to know before you pursue value investing.
What is value investing?
Value investing is an investing strategy focused on finding underpriced stocks that have the potential to produce steady gains. These value stocks tend to represent mature, financially stable companies, though some younger companies may fit the bill too.
How does value investing work?
Value investing works by identifying potential value stocks, buying them, and holding onto them in hopes their stock prices rise. This typically involves research, which you can do using stock-screening tools on financial institutions’ websites. Here are some ways to get started in researching value stocks.
Review the fundamentals
Review stock fundamentals, such as earnings, revenue, cash flow, and other financial data, across companies in the same industry. These points of reference can include:
- Price-to-earnings ratio (P/E) compares a company’s share price to its earnings per share, helping investors evaluate a stock relative to its past valuation and to other companies.
- Price-to-book ratio (P/B) compares a company’s share price to its book value per share, showing how the market values its net assets.
- Price-to-cash flow ratio (P/CF) compares a company’s stock price to the cash flow it generates.
- Dividend yield, which shows a company’s annual dividend payments as a percentage of its current share price, making it easier to compare payouts across companies.
Compare the metrics
Check how those similar stocks’ fundamentals stack up against each other. For instance, value stocks tend to have a lower P/E and P/B ratio than similar companies, the overall market, or the company’s past averages.
Understand the trends
Value investors often look for companies that are more mature and have steady cash flow, healthy balance sheets, promising earnings, and consistent dividends. The consumer goods, financial services, utilities, and industrials sectors have many value stocks. These companies tend to be less volatile than growth companies, which could help them potentially deliver steady returns over time.
Be patient
It could take a while for the market to recognize the value of a stock and for the price to increase accordingly. Keep in mind, though: Some stocks may never rise in value.
Advantages of value investing
Value investing has potential benefits that could make it an attractive strategy.
Long-term growth potential
Value investing is often viewed as a long-term strategy. Rather than seeking quick results, investors may hold stocks for years, recognizing that changes in market value can take time and may not occur.
Income from dividends
Value portfolios often include established companies that may offer dividend income and are generally considered less volatile than growth stocks, though returns are not guaranteed. You can use dividends to buy more shares over time or take them as steady passive income.
Disadvantages of value investing
Like other investment strategies, value investing comes with potential drawbacks that are important for investors to consider.
Requires research and analysis
Be prepared to do some research before deciding if a stock seems undervalued and fits your goals. That involves diving into a company’s metrics and comparing their performance to that of industry peers. Learning how to evaluate companies takes time and practice.
Potential for growth
You may need to wait months or even years for other investors to see the same potential in a value stock that value investors see. This means any gains may be slow.
Some stocks are value traps
A value trap is a stock that appears undervalued but is actually cheap because the company is struggling. Some companies trade their stocks at depressed prices due to deteriorating earnings, financial challenges, or a weakening business outlook. While some investors hope an undervalued stock may rebound over time, that outcome may not materialize, potentially resulting in losses.
Value investing vs. growth investing
Value investing and growth investing take different approaches to selecting stocks.
- Growth investors typically focus on companies they believe have the potential for faster growth, while value investors look for stocks they hope are priced lower than comparable companies, recognizing that the market may not reassess those stocks for an extended period, if at all.
- Value stocks are more likely to pay dividends than growth stocks because growth companies tend to reinvest profits in their business rather than pay out investors.
- Growth stocks tend to see bigger price swings than value stocks.
You don’t need to choose between these strategies. Many diversified portfolios include both growth and value stocks, allowing investors to draw on the potential benefits of each approach as they pursue their financial goals.
How to find value stocks
Finding value stocks to add to your portfolio often requires legwork. Here are a few ideas on how to do it.
Compare fundamentals in a stock screener
A tool like Fidelity’s stock screener allows you to filter your search based on P/E ratio, P/B ratio, dividend yields, and other criteria. Evaluate how stocks in the same industry measure up to each other to determine which ones might be underpriced.
Check the makeup of value funds
A shortcut: You can search for value-focused mutual funds or exchange-traded funds (ETFs) by searching “value funds,” “value ETFs,” or “value mutual funds” in the search bar of a financial institution’s site. At Fidelity.com, you can then click any of the funds the search calls up, select “Research,” then “Composition” to learn about some of the individual stocks that are in the fund. Then you can learn more about each of those stocks by clicking their tickers, the unique letter symbol used to identify the company stock.
Get financial professionals’ suggestions
You can explore research and commentary from market analysts and investment professionals or consult a financial professional for additional help with your research.
How to start value investing
Here is a simple step-by-step guide to get started with value investing:
1. Open an investment account
Be sure to select a brokerage firm that offers tools for researching value stocks and other potential investments. From there, you can open a brokerage account, individual retirement account (IRA), or health savings account (HSA) (if you have an eligible high-deductible health plan), all of which generally allow you to invest in value stocks. If your plan allows, you might even be able to invest in a value stock ETF or mutual fund through a workplace retirement plan, like a 401(k).
2. Fund your account
You can transfer money into your account from a checking or savings account. Alternatively, you can make check deposits or enroll in direct deposit. Once your funds are in your account, you can make trades and build your portfolio.
3. Choose your value stock investments
You can focus on individual stocks or value funds, like mutual funds or ETFs. In either case, a screener that reveals the companies’ fundamentals could help you identify investments you think are worth buying.
4. Factor in your investment goals
Not every value stock or fund will be right for you. Choose investments that fit your timeline, risk tolerance, and personal priorities. For example, if sustainable investing matters to you, you might look for value stocks in an environmental, social, and governance (ESG)–focused fund .
Buy your investments
Once you’ve chosen your investments, you can use your brokerage account to make trades. Over time, you may choose to create a portfolio that incorporates value investing.