In 2009, you could have bought just about any stock and it would have moved higher. Thanks to the huge bull market, growth stocks are no longer invincible.
In 2009, you could have bought just about ANY stock and you would have seen it move higher. Value stocks were a dime a dozen and even growth stocks were cheap.
Now, thanks to the huge bull market, valuations are stretched, especially in growth stocks.
This year, stocks that were trading at a premium to the market, those that were overvalued, were punished. The high growth stocks were suddenly no longer invincible.
So what are investors buying now that growth isn't so hot? They're jumping into value. Boring value stocks are back in vogue. But if the stock market is so expensive, how do I find value?
Value exists in every market, even in an aging bull market where nothing seems cheap. You just have to dig deeper to find it.
Start with a low price-to-earnings ratio
Value investors seek companies selling for under their intrinsic value.
The best place to start looking for value stocks, then, is in the price-to-earnings (P/E) ratio. The S&P 500 has an average forward P/E of 16.5, so a good place to begin is to look for companies with P/E ratios below that level.
Some investors, though, like to go even lower because then it's considered a deep value.
Why not try stocks trading with a forward P/E under 10?
There's no hard core cut-off. The beauty of value investing is that you can draw your own value threshold.
Add on a low price-to-book ratio
Value investing can't be done on the P/E ratio alone. Earnings, by themselves, aren't always an optimal indicator of whether a company is undervalued.
The price-to-book ratio (P/B) is also often associated with value investing. It stands for the price per share divided by the book value of equity, which are found on a company's balance sheet. Most financial websites automatically calculate a company's P/B ratio so you won't have to figure it out.
Just like the P/E ratio, the lower the P/B ratio, the better. Value investors, however, typically look for a P/B under 3.0.
Can you still buy growth?
Even the value investor yearns for growth in his or her portfolio. The growth stocks are simply too intriguing.
But just because you're a value investor, that doesn't mean you have to sacrifice growth.
Companies that are a value, but also generating strong growth, while rare, actually do exist. The railroads, for example, have been growing their earnings in the double digits over the last several years.
You could have been buying both value AND growth.
Now is the time to buy value
During a big stock market rally, it can be more difficult to find quality value stocks.
But the reward for value investors is finding that one company with great fundamentals that the market is ignoring and then cashing in the big gains when the market finally "gets it."
The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.