A value stock is any company that is undervalued by the stock market. Stocks can be undervalued for many reasons: some have not yet been discovered by the marketplace, some have been beaten down by the market due to short-term or immaterial events, and some due to negative market sentiment. A value investor seeks to exploit the fact that the stock is selling for less than it is truly worth, or what is known as intrinsic value.

P/E Ratio

One of the most popular methods of finding potential value stocks is using the Price to Earnings ratio, commonly known as P/E. This ratio represents the percentage of a company’s price per share to its earnings per share. A high P/E means investors are putting a large premium on the future earning potential of the company. Conversely, a low P/E means the company is priced very close to its most recent earnings. Nearly all value stocks will have a P/E lower than that of their competitors. Note that P/E ratios are relative. In some industries a P/E of 5 is considered low, while in other industries a P/E of 15 is considered low. Value investors must study the P/E ratios for all companies in an industry to identify the range of P/E ratios. When using public stock screeners a value investor should filter for low-P/E companies. Some screeners allow users to filter multiple criteria. If so, value investors should consider adding P/S (Price to Sales), P/BV (Price to Book Value) and P/CF (Price to Cash Flow) to their filters. Just as a low P/E could indicate a potential value stock, low P/S, P/BV and P/CF ratios can indicate potential value stocks.

Debt-to-Equity Ratio

Searching based on low P/E ratios is a great place to start, but investors must also pay attention to the Debt-to-Equity ratio, commonly known as D/E. A high D/E ratio means the company has a large debt load compared to its stockholder’s equity. Some companies appear undervalued on P/E and other price-performance ratios, but a company with much more debt than its competitors is not as flexible growth-wise due to allocating a larger portion of cash to debt payments. A stock that appears mispriced based on P/E may be properly priced if it has a large debt load. Steer clear of companies that fall in the top 50% of D/E ratios within each industry, regardless of P/E or other ratios.

Bad News

Many value investors look for companies with a recent bout of bad news. Examples include weather issues, employee strikes and loss of supplier contracts. Generally these issues warrant a decrease in the price of a company, but sometimes the decrease is too large due to a knee-jerk reaction from the market. Value investors can exploit this temporary and over-zealous price decrease, selling the stock once the strike is over or the company locks in a new supplier contract (at which time the market will rush back into the stock).

Robo Screener

ValueMyStock members have access to a proprietary value stock screener known as Robo Screener. Each day this screener automatically applies our Valuator ™ formula to all publicly-traded stocks, giving users a head start on which companies pass more stringent criteria than just P/E ratio. ValueMyStock members should use this screener as a starting point for finding potential value stocks. Members are encouraged to sort by Margin of Safety to see which stocks appear to be the most undervalued each day, then run these through our other valuation tools and conduct further research.

ValueMyStock Blog

ValueMyStock members also have access to our blog, which contains suggestions for undervalued companies and value investor education.