Uncover the top U.S. value stocks by identifying these key factors—while avoiding the negatives. Here’s what you need to look for.

A value stock is generally a stock that is reasonably priced, if not cheap, in relation to its sales, earnings or assets.

Investors hold onto top U.S. value stocks because they expect that other investors will in time recognize their value and push up their share prices. 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 uncover them.

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Holding the top U.S. value stocks will help you diversify and raise the quality of your portfolio

One of the most common investment platitudes you’ll hear is that investors should “have a plan (or system) and stick to it.”

This is good advice if your alternative is to invest without any sort of plan. However, unlike the time-tested value investing approach, many of today’s investment plans are not worth sticking with.

The best investment plans, or systems, use a variation of our Successful Investor approach and its strategy for value investing. That is, they revolve around choosing high-quality investments and diversifying your holdings.

There are numerous reasons why a top value stock might be underappreciated and inexpensive. The company might have experienced a period of stagnant growth (or even depreciating growth), which is why they fall into the category of “value stock.” Their business could have experienced temporarily low sales because of bad publicity, legal issues, or simply lagging behind competitors.

A value stock could go through a turning point where most investors ignore it, but savvy investors see that there is also a great potential for it to bounce back and make a bigger impact in the market.

Value investing vs. momentum investing: here’s what you need to know  when looking at top U.S. value stocks

Momentum investing is a strategy that aims to capitalize on continually improving news on a stock—especially positive earnings surprises. This means that momentum investors hope that recent winners will remain winners.

There’s nothing wrong with taking a closer look at stocks with momentum. But before you buy, make sure that they also offer some value in terms of their sales, earnings, assets and so on.

In contrast, the core of the long-term value investing approach is identifying well-financed companies that are well established in their businesses and for the most part 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.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of rising sales, if not earnings, as well as a strong hold on a growing clientele. 

Look for these factors to find the top U.S. value stocks: 

• 5 to 10 year history of profit. Companies that make money regularly are safer than chronic or even occasional money losers.
• Industry prominence if not dominance. Major companies can influence legislation, industry trends and other business factors to suit themselves. Minor firms, on the other hand, don’t have that power.
• 5 to 10 years of dividends. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.
• Geographical diversification. U.S.-wide is good, multinational is better. There’s extra risk in firms confined to one geographical area.
• Manageable debt. When bad times hit, debt-heavy companies go broke first.
• Freedom to serve (all) shareholders. High-quality value stock picks must be free of excess regulation, free of dependence on a single customer, and free from self-dealing insiders or parent companies.

Avoid falling into a value trap when searching for the top U.S. value stocks

Some of the measures that mislead you into buying the wrong value stocks are statistical. They include unusually high dividend yields, unusually low per-share price-to-earnings, or P/E ratios, and a low ratio of a stock’s 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.

Another way to fall into this trap is to put too much faith in the value of a brand name. A strong brand can sell a lot of a strong product, or keep an over-the-hill product going long after competitors have faded. But even the strongest brand name can only do so much. 

Use our three-part Successful Investor approach to discover top U.S. value stocks

1. Invest mainly in well-established, mostly dividend-paying companies.
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities).
3. Avoid or downplay stocks in the broker/media limelight.

Some value investors have started to focus on growth investing more. Do you agree with this approach?

What percentage of your portfolio is dedicated to value stocks? How have they performed for you?