When we look for the best Canadian value stocks, we start with a few basic ratios, but then go beyond these financial indicators for a deeper perspective

The search for the best Canadian value stocks, ones that will rise and hold their value over time, begins with looking for shares with sound fundamentals.

You can start with ratios when looking for the best Canadian value stocks

One of the key principles of successful investing is to include in your portfolio high-quality “value stocks”—stocks that are reasonably priced, if not cheap, in relation to their sales, earnings and assets. Typically, value stocks trade at prices lower than their financial fundamentals would suggest.

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As more investors come to recognize the value of these stocks, they begin to rise. Well-informed investors who recognized the value while the stock lingered at a cheaper price begin to reap the benefits of their foresight.

When we look for value stocks to buy, we usually start by looking at a few basic ratios.  For example:

• Low price-to-earnings ratio—a sign of a cheap or undervalued investment.
• Low price-to-book-value ratio—another sign that the stock is cheap in relation to other stocks on the market.
• High dividend yield—the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.

Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

Avoid these three common mistakes even when you’re investing in the best Canadian value stocks

Only following a select few financial indicators: Many investors decide to base investment decisions on just one or only a very few measures. For instance, they may want to see a p/e ratio below 15.0, along with, say, an earnings growth rate of 20% or more annually, and perhaps a 2% dividend yield.

This approach worked a lot better in the pre-computer age, when investing was more labour-intensive. Few people wanted to dig through old newspapers, annual reports and other material to get at the data. So, more gems were left to be found by those willing to do the work.

Today, if you find a stock with this (or any comparable) combination of highly favourable ratios, it probably comes with some more-or-less hidden drawback not covered by your system. Instead of steering you away from investments that you don’t understand, or that harbour hidden risk, this system could steer you toward them.

Investing in momentum stocks rather than looking for value: With momentum-based investing, investors tend to ignore value investing principles. Instead, they focus on buying stocks that are already going up, particularly in response to earnings reports that beat forecasts. These kinds of criteria are easy to track electronically, so momentum favourites tend to get overpriced quickly. When a momentum favourite reports an unexpected earnings downturn or warning, however, its share price can drop 25% to 50% instantly.

Looking for the best value stocks by focusing mainly on their dividend yields: Value stocks typically offer high dividend yields. That means their dividend payouts are high in relation to their individual stock price.

We’ve always placed a high value on dividend stock investing at TSI Network, mainly because it provides something of a measure of safety for stocks we recommend. After all, you can’t fake a record of dividends.

However, you should avoid the temptation to reach for yield. That is, choosing investments solely because they offer a high dividend yield.

A high dividend yield may signal danger rather than a bargain, if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

For a true measure of stability, focus on high dividend paying companies that have maintained or raised their dividends during economic or stock-market downturns. That’s because these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

Our Successful Investor approach includes tried-and-true value investing

When you follow a program like ours, you still need to make your own investment decisions. But our three-part Successful Investor framework tempers the effects of bad decisions and helps you cash in on your good ones.

The best investment plans or systems revolve around choosing high-quality investments and diversifying your holdings. Our three-pronged program takes that general description a little further. We advise you to invest mainly in well-established companies; spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; Utilities); and focus on companies that are outside the broker/media limelight.

What do you find to be the most challenging aspect behind using a value investing strategy?

What is the biggest mistake you’ve made with investing in value stocks?