Value Stock Definition
Value Stock is a stock that has the potential of selling at the higher price but due to the company’s adverse condition in the market, the stock is trading at the lower price than its actual worth based on its earnings, dividend or sales.
It is essential to understand that the stock’s intrinsic value (fair value) is not necessarily directly related to its current market price. The valuation of a stock depends upon its demand and supply in the market, and if there is a high demand in the market, the price of a share will increase, and if the company doesn’t have any good future aspects, then the price of the stock will decrease.
So, a value stock is such which is currently selling below its fair value, where fair value can be calculated using various measures like price to earnings ratioPrice To Earnings RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. , price to book value ratioPrice To Book Value RatioPrice to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share . There are situations when there projected earnings are lower, or we can say guidance given by the company is lower due to which the market have a pessimist view about the company’s long-term endeavor and hence the price of the share falls down and soon when the company is out of the all rumors and shows a good profit then the price of the share increases.
The value stock is purchased at a bargain price as the situation of the company in the market is going down, and the company is unable to perform to its best. As the market understands the potential of the stock, the price of the share will increase, and investors will able to earn substantial returns. Investors are betting that inefficiency that gives them an opportunity for considerable gain. An investor who is trading in value stock knows that he is trading at a price lower than they are worth and will gain when the price of the share increases.
Methods to Determine Value Stock
One of the most frequently used methods for figuring out what a company’s valuation should be is to use various financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.. A few common ratios are price-earnings, price-sales, and price-book ratios. Since the value stock companies are commonly found to have paid dividends in the last years, so the Dividend Discount ModelDividend Discount ModelThe Dividend Discount Model (DDM) is a method of calculating the stock price based on the likely dividends that will be paid and discounting them at the expected yearly rate. In other words, it is used to value stocks based on the future dividends' net present value. is the best method to valuation. Investors can calculate PE ratio and taking Avg PE ratio for the previous 5 years to evaluate whether share trading at a discount in respect of there intrinsic value or not, and also, the investor can calculate the intrinsic value using different online calculators and compare with actual prices in the market.
Examples of Value Stock
|Company||Last Price||Disc. to BV|
|V R Films & Studios Ltd||60.9||97.96|
|Binani Industries Ltd||34.35||95.23|
|Aban Offshore Services Ltd||53.95||92.32|
|Ansal Properties & Infrastructure Ltd||10.51||90.02|
|Global Offshore Service Ltd||11.42||89.27|
Let’s analyze this with the example of VR films; there was a time in June 2019, where there were only buyers of this stock; at that time, the stock price was Rs 90.00, and in August 2019, there were only sellers of this stock, price prevailing in the market was Rs 171.25. Investors were wise enough to research on this stock and made a market move.
Similarly, in the case of Binani Industries Ltd, the stock touched its 52 Week low of Rs 5.70 on 31st October 2019. On the next day, 1st November 2019, there were only buyers in the market for this stock, while before that, there was a situation that all the investors were selling this stock. The same situation took place in the case of Ansal Properties and Infrastructure Ltd.
Value Stock vs. Growth Stock
A good portfolio is such which has a mix of both types of stocks. The benefit of diversification can be considered with both the stocks.
#1 – Meaning – A growth stock is one that is of a successful company, who has substantial growth potential in the near future. The company is expected to have a level of earnings higher than the industry’s average growth rate. These stocks are said to be growth stocks while the Value Stock is determined to be currently undervalued compared to their intrinsic value or in their fundamental worth.
#2 – Price Earnings Ratio – The market price of share / last year EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.. In case if the projected PE ratio is more than the current PE ratio, then the stock is considered as a value stock. However, Growth stock has a low Projected PE ratio as compare to the Current PE ratio due to the denomination factor of EPS.
#3 – Investor’s Expectation – The Investor invest in value shares in believing that the price of a share will increase when the broader market recognizes its full potential. In contrast, the growth stock investors think that there will be high earning on shares irrespective of the market conditions.
#4 – Returns – Both types of stocks are guaranteed to receive the returns for future capital appreciationCapital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.. Also, such investors receive a dividend in return. Simultaneously, growth companies don’t pay many dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. in the belief that investing the surplus funds in the business is a viable option for expansion and growth instead of distributing the dividend.
#5 – Risk Level – Growth stock carries a higher risk, which is led by comparatively high volatility and driven by volatility, the price of the stock is higher, as compared to the fundamentals of the company. On the contrary, it is comparatively a safer bet to invest in value stock, which is expensive as compared to peer stock. Hence, there is comparatively lesser trading in the stock and hence lesser volatility.
The diversified portfolioDiversified PortfolioPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio. is the best portfolio for investment. Investors can gain exposure to the portfolio of blended funds, where the value stock and growth stock are put together for maximum returns. Investors should focus on value investing, which involves buying a company at a price lower than the intrinsic value and selling it when the price reaches its value.
This article has been a guide to Value Stock and its definition. Here we discuss methods to determine value stock, its importance along with an example, and its differences from a growth stock. You may learn more about financing from the following articles –