What are value stocks?

Value stocks may be found where the share price of a company is lower than its true valuation. An investor should look at the real value of companies and find the best shares. Value stocks represent a company whose value is greater than is reflected in stock prices.

Choosing value stocks

A value investor A value investor may find these shares and stocks by knowing how to value a company based on the estimated future cash flows. Where the future net cash inflows to the business may be estimated and discounted for the time value of money, a serious investor may arrive at a view of the real value of the business. Where the price of the shares is clearly lower than the intrinsic value of the company, this represents an investment opportunity. Shares may move up and down in the short-term as a result of emotional responses by the market to general economic news and this may give rise to investment opportunities to the serious value investor. The investor who is looking for value and a long-term investment in shares, should take the advice of Warren Buffett who suggests that investors should only look at businesses that they understand. The investor should have enough knowledge of the business to arrive at a reasonable estimate of the value of the company, and if the investor is unfamiliar with the type of business, it may be difficult to do the calculations and recognise an investment opportunity. Moreover, where the investor’s computation reveals only a small difference between the share price and the value of the company, it is best to take a cautious approach and not to purchase the shares.

Long-term value investing

The value investor The value investor should look for companies that are likely to still retain their competitive edge ten or twenty years into the future. Therefore, the best value is more likely to be found in those industries that will not undergo radical change in the coming years. Although all industries are continually introducing incremental technological, product and marketing changes, an industry that operates in a
fast-changing environment may not be the best area for investment. Very competitive, quick changing environments may give an opportunity for large
short-term gains, but stocks of these companies are not a good target for
long-term value investing. A value investor should therefore invest in a business that can be understood and has prospects over the long-term. The best stocks may be found where the company has an open and straightforward management team that takes wise decisions on new projects and capital investment. Above all, the share price should be reasonable compared to the current valuation on the market.