Value investing

The words “price” and “value” are very close in meaning, but they aren’t exactly the same: price is what you pay for something, whereas value is what it’s actually worth. Value investing is an investment strategy that looks for instances where the price of a stock doesn’t accurately reflect its value, and invests accordingly.

A value investor will seek to buy securities “at a discount” when they believe the price has fallen below the actual value, or seek to sell securities when they believe the price will be artificially inflated. Value investing is generally used to describe an active trading approach that seeks to sell at a profit, but there’s no rule that says you can’t buy stocks that you think have long-term value and hold them for the long-term.

The term “value” is used in more than one context when talking about investments. 

Value stocks is a term used to describe securities that are relatively inexpensive, typically boasting lower price-to-earnings ratios and higher dividend yields than other stocks. These stocks are typically contrasted with their growth stock counterparts, which have high price-to-earnings ratios and low (or no) dividends.

Value investing in the context of strategy refers to the strategy of buying stocks that are undervalued and/or selling stocks that are overpriced. It doesn’t necessarily matter if these are value stocks or growth stocks, so long as there’s a perceived difference between the current price and the actual value.

Figuring out a company’s actual value is the main focus of fundamental data analysis.

There are a lot of factors to take into consideration, both on a company level (such as revenue, profit margins, brand strength, and corporate leadership) and on an industry/market-wide level (such as interest rates, market saturation, geopolitical events, and shifting market trends). Many of these company-level data points are available through your Questrade platform of choice, including Market Cap (the total value of all shares), EPS (corporate earnings per share), and P/E ratio (share price divided by earnings per share).

Corporate guidance and earnings reports are another good source for fundamental data. Every publicly traded company is required to release corporate reports to its investors on both a quarterly and annual basis, disclosing vital information about key fundamental data points such as earnings data, corporate governance, and more.

The amount of readily-available data is both a benefit and a challenge for value investors. On one hand, you have a lot of different data points to help you make an informed decision, but on the other hand, so much data can be overwhelming. Plus, while many data points are supported by facts and figures, other fundamental data points are much less cut-and-dry, such as if a new CEO is going to be a good fit, how a trade embargo might affect a company’s supply line, or what customers think of their brand image. 

Ultimately, it’s up to the individual investor to make their own decisions about which data points to focus on, and how to interpret them, when determining where to set the value of any given security.

While value investing is built upon the notion of doing your homework and buying when you find a good deal, it’s important to remember that there’s no such thing as a foolproof investing strategy. Like any other strategy, value investing has its criticisms and potential drawbacks. For example:

A change in price may just be the result of an actual change in value. It’s possible for a change in real value to look temporary from a certain point of view, especially when dealing with data that’s up for interpretation. For example, a competitor’s hype could be all bluster, or they could be about to dominate the market with a new product.

Changes in sentiment may be completely justified. While changes in price can be fueled by emotional reactions, that doesn’t necessarily mean that the emotional reactions are unjustified. For example, a PR fiasco could be overblown in the short-term, or it could have caused irreparable damage to the company’s brand reputation.

It can be difficult to know when to give up on a call. If you’re incorrect about the difference between cost and value, and the price doesn’t behave as you thought it would, it’s difficult to know when to cut your losses.  This applies more to those who use value investing as an active trading strategy; if you’re using value investing to pick up long-term growth stocks at a discount then you will have simply bought securities you wanted anyways at full-price instead of your perceived discount.

When it comes to any investment strategy that revolves around fundamental data, you’re obligated to address the technical data analysis elephant in the room. This is because one of the key tenets of technical data analysis as a whole is the idea that, because there are so many investors with access to the same fundamental data, any changes in real value will be immediately priced into the market.

While it may be true that there are a lot of very well-educated people watching the fundamentals of any given security, it’s also true that there are many investors who aren’t paying attention to fundamentals at all, including both more emotional investors and the technical data analysts themselves. You could look at this debate as two forces pulling at the price, with value-focused investors pulling the price towards its true value and non-value-focused investors pulling the price away. The degree to which value investing is viable depends on which force you think is pulling hardest at any given point in time.

It may also be worth pointing out that active value investing based on fundamental data and active trading based on technical indicators aren’t quite so different in the end. After all, both are looking to anticipate deviations from the current pricing trend, in a sense using different roads to reach the same destination.

Note: The information in this blog is for information purposes only and should not be used or construed as financial, investment, or tax advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.