Financial Education

Value investors look for stocks that are cheap, typically relative to either their assets (price/book) or their earnings (price/earnings.)  Value investors often believe that, in aggregate, other investors are willing to pay too much for popular glamour stocks and that the less popular stocks are underpriced due to neglect.  Efficient market believers usually ascribe the cheaper price to risk factors that investors are accurately pricing into the stocks.

Anyone can see that a stock is cheap. Successful value investors need to understand why a stock is cheap. Is it simply due to neglect, or is there a good reason for the low value? Are other investors missing something, or is the value investor failing to interpret the market’s reason for the low valuation? Is there a catalyst to make the stock rise to its proper value, and if not how long must one wait for the market to recognize the mispricing?

The main subsets of value investors are those who look for a low P/E ratio (usually in hopes of mean reversion), those who seek high dividend yields (and accepting most of the return potential as dividends), and contrarians. Contrarians seek companies that often have little or no earnings and are trading near or below book value. Often this is due to cyclical weakness that can be reversed during the cyclical recovery. Other times the contrarian investor may expect management to turn the performance around.

Source: Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)

For more information, see all articles on: Asset Allocation, FInancial Planning, Investing in Stocks, Investment Returns, Portfolio Management, Ratio Analysis, Valuation

See also:

Types of Benchmarks

Growth Investment Styles

Equity Investment Styles

Core-Satellite Approach to Equity Manager Selection

Types of Hedge Funds