Want to find value stocks and beat the market? Yes, it’s possible – I’ve been doing it for over a year. While I can’t give you financial advice, I can show you how I find and choose these stocks.
Let’s go.
Disclaimer: This is all my personal opinion and not financial advice or any other kind of professional advice.
Why Invest in Value Stocks?
Well, let’s start with the fact that it’s Warren Buffet’s investing philosophy. If that’s not enough, know that when you’re a value investor, you’re essentially buying shares of companies that are a bargain, meaning they’re cheaper than they would be if their price truly reflected a company’s worth. Plus, they’re typically mature, stable businesses that pay dividends.
Think about it this way: imagine a town that has a super-popular and successful restaurant. Town gets hit by a hurricane, temporarily wiping out its economy. People are afraid, and the restaurant’s owners put it up for sale at a crazy cheap price. You buy it, knowing that it will be worth a lot more when the town rebuilds and the economy recovers.
That’s basically the idea behind value investing. Now, let’s look at how we can find great value stocks.
5 Ways to Find Value Stocks & Beat the Market
I’ll start with an easy, simple, and effective way.
Find Value Stocks By Investing in a Value Stock Mutual Fund or ETF
This is the simplest method to find value stocks: you simply buy a “value” mutual fund or ETF. For example, the Vanguard Value ETF (VTV). It has big pros, but also some cons. I use this method for a large part of my portfolio simply because it’s relatively safe, easy, and low-maintenance.
Mind you, you don’t have to buy just one ETF; I encourage you to buy multiple, for further diversification. For example, I find that low and mid-cap value ETFs can provide excellent returns and good diversification.
Pros of Mutual Funds and ETFs
- Super simple and easy to manage – you just buy one or more value ETFs and hold for as long as you want.
- You don’t have to look at your account often. If a company goes bankrupt or ceases to meet value criteria, the fund manager will simply replace it with another one.
- Instant diversification and relatively low risk.
Cons
- You must pay fund fees, though these are generally very low nowadays.
- You will own stocks that you don’t necessarily want, simply because the fund buys them.
- If the entire stock market is overpriced, the “value” stocks in the fund can still be overpriced. They might be “value” relative to the overall market, but still quite expensive.
Buying Whatever an Article Calls “Value”
This method to find value stocks relies on reading financial articles and taking stock picks recommended by the authors. You know, those articles titled something like “5 Value Stocks to Buy Right Now”. It’s fairly easy, but has drawbacks.
Pros
- Easy. You just buy whatever the author recommends.
- The recommendations will probably be good, if the author has the necessary expertise and the publication is reputable.
Cons
- If the author sucks, the recommendations may suck, too.
- You have to buy lots of stocks to achieve diversification.
- It can be hard to differentiate between good and bad authors, especially if you’re a beginner. How do you know who to trust?
- You have to look at very recent articles, since things change quickly in the markets.
Going by P/E Ratio
Price/Earnings (P/E) Ratio is a traditional value metric. Generally, a P/E Ratio under 20 would indicate value, though some people take that to 25. The lower, the better. I like 15 or less.
Pros
- Simple. Just buy stocks that have a low P/E Ratio. For example, under 20 or under 15.
- To improve your criteria, make sure they pay at least 2% dividends and have existed for over 10 years.
Cons
- The higher the market goes, the tougher these stocks are to find.
- If it’s your only criteria, you might end up buying stocks that are cheap not because they’re undervalued, but because the companies actually stink – you don’t want to own that!
- P/E Ratio can be very unreliable (almost useless) in many sectors, such as tech.
Buying Dividend Stocks that are at a Historically Low Price
Another (perhaps controversial) way to find value stocks is to find stocks that pay dividends (a characteristic of many value stocks), and that are at historically low prices. This means that you look at a price chart, and buy stocks that are close to their low of one year or more.
Pros
- You can find hidden gems that may not be uncovered by other methods.
- Quality stocks that are at a historical low tend to rebound, setting you up for big gains.
Cons
- This is an unconventional methodology that can result in bad picks if you choose stocks that are on a downturn for a good reason.
- You need to make sure that you are picking quality companies, which takes a bit of research.
Buying Stocks that are Below Analysts’ Fair Value Estimate
Lately, this has been my favorite way to find value stocks. What you need is a broker that provides access to good analyst reports (for my individual stock-picking, I use Robinhood Gold, which features Morningstar reports for most stocks). Look at the “Fair Value” assessment of a stock that you think is high-quality. If the present price is below fair value, buy. If it’s equal to or above fair value, pass.
Pros
- Someone who has really studied the company provided an estimate of fair value, so it’s not a bad idea to rely on that.
- It’s a way to get around using the classic P/E metric, and will help you find value stocks where P/E does not work.
Cons
- You are relying on one analyst’s opinion, which can be outdated or simply wrong.
Which Way to Find Value Stocks is the Best?
Honestly, I use them all. That said, my main methodology is to mostly buy ETFs when the market is coming down, since I am buying a basket of stocks at what is likely to be a lower price. In other words, a falling market will take many stocks down with it, including the ones in the ETFs.
When the market is up, I use other methods, mainly P/E and buying below analysts’ “fair value”. Since the market is up overall, I need to be pickier and find individual stocks that are a bargain, rather than buying something broad-based like an ETF.
You Still Need to Buy Quality Stocks
Before I go, just a reminder that you still need to buy stocks that you believe in and that are high-quality. For example, I won’t buy most oil companies no matter what, simply because I personally believe that oil as a big energy source is fading into the past.
If you don’t want to do this analysis, just buy value ETFs. Ideally, but more each time that the market dips. This is a strategy I use with one account, and I handily beat the S&P 500 with it!
Summing It Up
If there’s one thing I love about value stocks, it’s the dividends. Most pay them, meaning that, on top of price appreciation, you get a tax-advantaged annual yield of around 2-5%. Plus, they are generally more stable, mature, and safe, compared to growth stocks. That’s why I am mostly a value investor. (I do buy growth stocks, but it’s a minor part of my portfolio).
If you don’t have a passion for investing and stock-picking, I suggest that you just buy value ETFs. On their own, they work great and don’t require much maintenance. But if you like the game, then also try the other methods.
Happy investing!
How do you prefer to find value stocks?
Love the blog, Miguel! I’m a big fan of Vanguard ETF’s myself. I agree with the basis of your strategy as I also have more value stocks than growth. Would love to see more examples of stock picks in the future. Keep up the great work!