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Value Investing Starts With These Five Metrics
Value investing is a tried and tested way to success in the world of investments. The top investors in the world today like Warren Buffett and George Soros have used value investing to pile up massive amounts of cash. If you can study five metrics carefully and apply this knowledge to your investing, you will go a long way in your value investing approaches.
Fundamentals are the number one thing in value investing. Basically, it is a firm's financial and operational data. Revenue growth and earnings per share are some of the numbers that can help investors immensely when it comes to selecting the best stocks.
Look to pick stocks by analyzing the price-to-earnings ratio (P/E). It is calculated by dividing the share price of a stock by its earnings per share. When it comes to fundamental ratios, this one is very valuable. Generally, the best way to pick stocks is to go for those that have a lower P/E.
Try to compare stocks that are in the same industry when utilizing the P/E. High-tech stocks have a P/E sometimes nearing 60, whereas energy stocks may have a multiple in the low teens.
We arrive at the price-to-book ratio (P/B) by dividing the share price by the net assets of a stock, minus intangibles like goodwill. The P/B is considered to be rather conservative and this is probably why Soros and Buffett love making use of it. The P/B only takes account of the tangible assets and ignores intangibles that are hard to measure in terms of value.
It is pretty difficult to go by the P/B ratio always especially in the case of some companies that have a big intangible value arising from excellent brand recognition or other such thing.
If you want to stick by the value investing rule book, see if the stock in question has a P/B less than 1.5. This signifies a good buy.
The debt-equity ratio is a handy tool for investors. If you're try to identity a good value stock, it is mandatory to compute or otherwise come up with this particular ratio. Companies finance themselves in one of two ways: debt and equity. Loans and bonds are debt instruments. Issuances of shares of stock is equity.
Be very wary of companies that are heavily financed by debt. They can be spotted by comparing the debt/equity figure with the general numbers in the industry.
Free Cash Flow
A company that is bringing in positive free cash flow is a good buy. Accounting trickery often gets in the way of figuring out the actual free cash flow. In addition, firms also use either GAAP or IRFS accounting principles when reporting financials. So try to zero in on free cash flow and study it carefully because it tells you how much cash a company has. During tough times, it is the cash that keeps a company thriving.
This ratio is a hybrid version of the usual P/E in that it also accounts for earnings growth. The PEG has become a necessary tool for value investors as they look to pick the next bullish stocks for the following quarters. The key is to look for companies that are growing but remain undervalued.
Numbers don't confirm everything
Valuing a company is a far from easy task and it takes many years of study. Sometimes the numbers tell a certain story, but it could be far from the truth. This is because there are other factors that affect a company's valuation such as the quality of the management.