For value investors, this week’s one-year anniversary of the “bottom” of the stock market is truly the best of times and the worst of times.
A year ago, stocks were cheap. It was a value investor’s dream as P/E ratios fell well below the historic norm. Almost all stocks were suddenly value stocks as panic gripped the Street.
And now, this market appears to be the value investor’s worst nightmare.
The mega-rally literally lifted all stocks, which has been great for investor portfolios. When it comes to value investing though, the rally changed the landscape dramatically as even stocks that would normally lag the market surged sharply higher.
But there is hope for the value investor. Value investing isn’t dead. Undervalued stocks are still out there. It’s just a matter of digging deeper than usual to find them.
Look Beyond the P/E Ratio
Most value investors know to look at the price-to-earnings ratio (or P/E) to find stocks that are undervalued. To find true value: the lower the P/E, the more undervalued the stock.
Many value investors use a P/E under 20. This method to search for value stocks is a great starting point in normal markets, but stocks are more expensive now.
So while you should start with the P/E ratio, don’t end there. You’re going to need some more tools in your arsenal to find the true value stocks.
3 Tools to Dig Deeper for Value Stocks
1) Use Price-to-Sales
Many value investors neglect the sales component, but sales cannot be easily manipulated. There are no “charges” or “exclusions” or other accounting hocus pocus with sales. They usually are what they are; and they’re easy to compare quarter over quarter and year over year. The healthier the sales growth of an organization, the healthier its potential for profit growth. The lower the Price to Sales ratio (P/S), the better. So look for stocks with a P/S ratio of less than 1.
2) Growth is still your friend
Growth? For value investors? Yes, value investors can use the PEG ratio to find growth stocks trading at reasonable prices. As you probably already know, the PEG ratio is simply the price-to-earnings ratio (P/E) divided by earnings growth. The lower the PEG ratio, the more undervalued the stock is. So look for stocks with PEG ratios under 1.
3) Look at the Industry Rank
This is a little known factor that, when used with value metrics, can give you powerful results. Zacks ranks industries according to improving earnings prospects, so value investors can look at the Industry Rank lists to get an idea of which industries have rising earnings estimates. The Zacks Industry Rank is the average of the Zacks Rank for all companies in the industry. Just like with the Zacks Rank, the lower it is the better. So a Zacks Industry Rank of 1.00 is better than one of 4.35.
Value Is King in Bull and Bear Markets
Numerous studies of various bull and bear markets around the world come to one conclusion: it may not be glamorous, but value investing outperforms growth investing over the long term.
Is it any surprise that one of the greatest investors of all time, Warren Buffett, is a value investor?
Now is the time to stay the course. Rally or no rally, value is still king.
Digging for Value Every Day
I know how frustrating it is to try and find value stocks as the markets continue to climb. I seek out value stocks every trading day with the Zacks Value Trader trading service, and some days there just isn’t much to get excited about. But all it takes is finding a hidden gem here or there for a value investor to really profit.
Just a few days ago, for instance, I added a big international oil company to the Value Trader portfolio. It has great “digging deep” value fundamentals, such as a price-to-sales ratio of just 1.08 and a forward P/E of 11. It also has a Zacks Industry Rank of 2.20, placing it 20th out of 264.
The Value Trader dug deep to find great stocks during last year’s rally. The portfolio returned 47.5% last year, which is nearly double the S&P 500 over the same time period, proving that value hasn’t gone away, you just have to know where to look.
I invite you to see what stocks are in the portfolio and learn the secrets behind the Value Trader‘s success. You’ll want to look into this right away because the remaining spots in the service are quickly being snapped up. There’s a special savings that ends at 11:59 pm Saturday, March 13.
Tracey, as Zacks Value Stock Strategist, helps Zacks.com customers find the best value stocks through her daily commentary. She is also the Editor in charge of the market beating Zacks Value Trader.