What’s the best value investing strategy? Our tips will help you identify the best low-priced value stocks

Virtually all successful investors have some form of a value investing strategy. Many successful investors also have some knowledge of technical analysis, and most have some knowledge of a variety of other tools and shortcuts. But virtually all successful investors take a broad view, and apply everything they know to their investing decisions.

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.

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Successful investors owe their success to much more than just one relatively narrow approach to the market, especially in a value investing strategy

To succeed as an investor, you have to take a broad view in making investment decisions. Technical analysis and other narrow views do sometimes seem to “work” for lengthy periods, of course. But they only work for a minority of the time, and they never work consistently. Instead, they run hot and cold. As with all random events, their successes occur in bunches.

These bunches of successes come in random lengths, with random beginning and end points. It’s easy to see how this applies with technical analysis, which has an arcane air about it. But the same principle works for something as straightforward and commonsensical as, say, value investing.

Value investing fans zero in on financial statistics and ratios as an indicator of what to buy. They like to buy stocks with low ratios of stock price to per-share earnings, cash flow, sales and book value. They assume that if you get enough value in your stock buys, indicated by low numbers in these ratios, your profit is virtually assured, in the long run if not in the short. Of course, there are no guarantees—the problem is that while a 9.0 p/e is attractive, the price can still drop enough to cut the p/e down to, say, 7.0. Then too, a low p/e is no guarantee that the “e” or earnings won’t drop. (When the ‘e’ drops, the p/e automatically shoots back up again.)

In fact, a low p/e and other low readings in value-investor ratios may simply mean that well-informed investors are selling the stock and pushing down the “p” or stock price. If so, it probably means they see flaws in the company’s situation or outlook that investors are generally missing.

Even so, ratios are a good starting point:

A few basic ratios to use in your value investing strategy

One of the key principles of successful investing is to buy 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.

When we look for value stocks to buy, we usually start by looking at these ratios:

• Low price-to-earnings and price-to-sales ratios—signs 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.

The best value stocks

Finding top value stocks is among the most profitable strategies of successful investing.

High-quality value stocks are reasonably-priced stocks, if not cheap, in relation to their sales, earnings or assets. Investors hold onto them because they expect that other investors will recognize their value and push up the share price.

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.

Identify these safety factors as part of a value investing strategy

• 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.
• Geographical diversification. Canada-wide is good, multinational better. There’s extra risk in firms confined to one geographical area.
• 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.

Analyze these financial factors as part of a value investing strategy

• 5 to 10 year history of profit. Companies that make money regularly are safer than chronic or even occasional money losers.
• 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.
• Manageable debt. When bad times hit, debt-heavy companies go broke first.

Do you have additional suggestions for a value investing strategy? If so, share your thoughts with us in the comments.