Whether it is shopping at the mall or investing, folks like knowing that they got a good deal. The difference between the two scenarios is that not every cheap stock out there represents a good value. However, there are ways for investors to find inexpensive value stocks without falling into value traps.
Understand Value Stocks
The first step in hunting for good values among value stocks is understanding the key differences between growth and value stocks. Value stocks are not necessarily confined to just one or two sectors. However, value stocks are usually found in the large-cap corner of the corner market. Most true value stocks are older companies that, for a variety of reasons, have fallen out of favor with investors, if even temporarily. Many value stocks pay dividends whereas many growth stocks do not. Sectors rich in value stocks include consumer staples, health care, industrials and utilities.
The price-to-earnings, or P/E ratio, is a classic valuation tool. A company’s P/E ratio is its current share price divided by earnings. For example, a $100 stock with $5 per share in earnings would have a P/E ratio. Investors can use the P/E ratio to find cheap value stocks by integrating P/E as part of their screening methodology. "Companies with low P/E ratios and solid growth rates may be great investment opportunities that the market is discounting," according to financial adviser Mark Riddix.
The price-to-book ratio is another often used valuation tool and it is usually paired with the P/E ratio in an effort to find value stocks. The ratio is the current stock price divided by total assets minus intangible assets and liabilities. Investors looking to combine P/E and price-to-book in one screen can do so with the Bing Stock Screener by using the custom tab. From there, select the "add filter" button and then the "valuation" group. The next step is to add P/E and price-to-book as the screening parameters.
There are other factors to consider when hunting for inexpensive value stocks. For example, the best bargains are not likely to be found among stocks that have recently run up. Rather, investors will find value with stocks that have been ignored or unloved by the market. That does not mean incurring significant risk, though, as focusing on low-debt, highly profitable companies can lead investors to some winners among value stocks.
Todd Shriber is a financial writer who started covering financial markets in 2000. He worked for three years with Bloomberg News and specializes in analysis of stocks, sectors and exchange-traded funds. Shriber has a Bachelor of Science in broadcast journalism from Texas Christian University.