Value investing is an investment strategy that involves picking stocks that appear underpriced by fundamentals. It was popularized by Warren Buffett and focuses on finding stocks trading below their intrinsic values. For beginners who want to try value investing, here are some simple steps to find undervalued stocks for your portfolio:
Screen for stocks with low P/E and P/B ratios
The price-to-earnings (P/E) ratio and price-to-book (P/B) ratio are two key metrics used in value investing. Look for stocks in your investing universe that have low P/E and P/B ratios relative to their industry peers or the overall market. This signals the stocks may be undervalued.
Evaluate historical earnings performance
In addition to current valuation ratios, examine the historical earnings performance of the company. Value investors favor stable, established companies with a long track record of steady earnings and dividend growth over time.
Research qualitative factors affecting intrinsic value
Don’t just rely on quantitative ratios. Do qualitative research on factors that may impact the intrinsic value of the company like industry growth trends, competitive advantages, management reputation etc. This will give you a better sense of whether the low valuation ratios actually signal an undervalued opportunity.
Have patience and wait for margin of safety
Even after identifying an apparently undervalued stock, value investors wait patiently for an even wider margin of safety before buying. This means waiting for the stock price to drop significantly below your estimate of intrinsic value. This provides a buffer against mistakes in your analysis.
Hold for long term through business cycles
The final key tenet of value investing is to hold stocks for long periods, ideally 5-10 years. By holding through market cycles, short term price volatility matters less while the underlying business value compounds over time. Patience allows the portfolio to benefit from the eventual closing of the valuation gap.
The key principles of value investing like focusing on intrinsic value, margin of safety, and long-term holding can generate solid returns for beginners. By screening for stocks with low fundamentals ratios and digging deeper into qualitative earnings power judgments, beginners can find high-quality undervalued stocks.