Does value investing still work? Use the principles of successful value investing and you might be pleasantly surprised

At the core of the Successful Investor approach to strong value investing returns is identifying well-financed companies that are established in their businesses and have a history of earnings and dividends. They are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does.

Does value investing still work? Value investors need to have longer-term mindsets when it comes to investing. Long-term wealth building strategies aren’t built by aiming for immediate outsized returns. They are built over time, and most importantly, by learning not to repeat the market mistakes of the past.

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Does value investing still work? It does if you pick the right stocks

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele.

High-quality value stocks like these are difficult to find, even when the markets are down. But when you know what stocks to look for, you can discover them. Here are three of the financial ratios we use to spot them:

• Price-earnings ratios
• Price-to-sales ratios
• Price-cash flow ratios

Does value investing still work? Yes, if you avoid value traps

Some of the measures that lead you into value traps are statistical. They include unusually high dividend yields, unusually low per-share price-to-earnings or P/E ratios, or a low ratio of stock price to book value or other measures of per share value.

Any of these measures can make it seem like a stock is a bargain. But in fact, any of them can simply be due to a low stock price that is the result of selling by well-informed investors who recognize a dismal long-term future.

Consider goodwill to get the greatest benefits from a value investing approach

In analyzing a company’s financial statements, a key concern, and a potential pitfall for investors, is the amount of goodwill that it carries as an asset on its balance sheet. Goodwill is an accounting entry that reflects the price that the company paid for its acquisitions, minus the value of the tangible assets, like land and equipment, that it received as part of the acquisition. The term means “value as a going concern.”

Goodwill acquired in an unwise acquisition can lose value overnight. When that happens, the company has to write it off against earnings. At worst, the company might have to write off most, if not all, of its goodwill.

If that writeoff wipes out most of the company’s shareholders’ equity, and/or most of a year’s earnings, it can devastate the value stock pick’s share price. In most cases, that’s a cost-if-something-goes-wrong to avoid at all costs.

Be cautious of economic forecasts when you consider value stocks, so you can make better decisions and avoid losing money

You need to avoid putting too much faith in the stock market as an economic forecaster. Sometimes the market gives advance warning about coming recessions and economic bubbles. Other times, it predicts economic bubbles that never come. (This, by the way, is true of any economic forecast.)

Up to a point, national and world economies are self-correcting. They rise and fall in a series of spurts and setbacks. The setbacks always show some sign of turning into recessions. They rattle investors and upset the market. But few ever lead to serious, lasting damage.

The most experienced, successful investors feel skeptical, if not downright cynical, about economic forecasts for three reasons:

1. Fame as an economist has little to do with forecasting skill.
2. Accurate economic forecasts are rare—certainly rarer than profitable stock market recommendations. There are simply too many economic factors interacting in too many ways. That’s why nobody guesses right every time, and even the best economists can be right on in one year and dead wrong the next.
3. Even when an economic forecast is right, it still may not offer helpful investing advice. That’s because the stock market anticipates economic trends much better than any economist, and moves up and down ahead of them.

Use our three-part Successful Investor approach for value investing success

We advise you to invest mainly in well-established companies; focus on companies that are outside the broker/media limelight; and spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; Utilities).

The best investment plans or systems use some variation of this approach. That is, they revolve around choosing high-quality investments trading at reasonable p/e ratios and other fundamental measures, plus diversifying your holdings.

Value stocks are viewed as a patient investor’s game. How suited is your investment style to value investing?