What Is a Value Stock?
- Common characteristics of value stocks include a high dividend yield, low P/B ratio and/or a low P/E ratio.
- A value stock typically has a bargain-price as investors see the company as unfavorable in the marketplace.
- A value stock typically has an equity price lower than stock prices of companies in the same industry.
Understanding Value Stock
A value stock is a security trading at a lower price than what the company’s performance may otherwise indicate. Investors in value stocks attempt to capitalize on inefficiencies in the market, since the price of the underlying equity may not match the company’s performance.
Common characteristics of value stocks include a high dividend yield, low price-to-book ratio (P/B ratio) and/or a low price-to-earnings ratio (P/E ratio). Investors can find value stocks using the "Dogs of the Dow" investing strategy by purchasing the 10 highest dividend-yielding stocks on the Dow Jones at the beginning of each year and adjusting the portfolio every year thereafter.
In contrast to value stocks, growth stocks are equities of companies with strong anticipated growth potential. A balanced, diversified portfolio will hold both value stock and growth stocks. Investment managers refer to these as a blend fund.
How to Spot Value Stocks
A value stock will have a bargain-price as investors see the company as unfavorable in the marketplace. Typically, a value stock has an equity price lower than stock prices of companies in the same industry. Value stocks may also sit within a sector that trades at a discount to the broader market. Negative publicity relating to unsatisfactory earnings reports or legal problems are indicators of a value stock as the market will negatively view the company’s long-term prospects. A value stock will most likely come from a mature company with a stable dividend issuance that is temporarily experiencing adverse events. However, companies that have recently issued equities have high-value potential as many investors may be unaware of the entity.
Risk and Return of Value Stocks
For all their potential upsides, value stocks are considered riskier than growth stocks because of the skeptical attitude the market has toward them. For a value stock to turn profitable, the market must alter its perception of the company, which is considered riskier than a growth entity developing. For this reason, a value stock is typically more likely to have a higher long-term return than a growth stock because of the underlying risk.
A value stock may need some time to emerge from its undervalued position. The risk of investing in a value stock is that this emergence may never materialize.
Example of Value Stocks
As of June 2019, large money center banks represent value stocks. Bank of America Corporation (BAC), JPMorgan Chase & Co. (JPM), Wells Fargo & Company (WFC) and Citigroup Inc. (C) all trade at a significant discount to the market based on earnings. For example, Citigroup has a P/E ratio of 9.67 compared to 19.12 for the average S&P 500 company.
Investors can gain exposure to a portfolio of value stocks using exchange-traded funds (ETFs). Three of the largest value ETFs based on assets under management (AUM) include the Vanguard Value Index Fund ETF (VTV), the iShares Russell 1000 Value ETF (IWD), and iShares S&P 500 Value ETF (IVE). All three funds are specifically designed to track the price and yield performance of U.S. large-cap value stocks.