When you’re looking for good investing options in 2022, you may want to take the Warren Buffett approach and focus on value investing.
You can’t mention value investing without mentioning Buffett, and you can’t mention Buffett without mentioning Benjamin Graham. (Buffett follows the author of The Intelligent Investor Graham’s value investing approach, which means choosing securities that have low prices but higher overall worth.)
(You may have already heard one of Buffett’s most famous quotes: “Price is what you pay. Value is what you get.”)
Can just anyone implement value investing, or does it take a seasoned investor to make it happen? The truth is, anyone who educates themselves about the concepts of value investing, does appropriate research and goes in for a buy-and-hold strategy has the potential to succeed.
Let’s walk through how to identify undervalued companies and make decisions based on several metrics. Yes, you can implement value investing as a strategy in 2022.
What is Value Investing?
Some companies are undervalued based on their long-term growth potential — some companies’ prices are low compared to their intrinsic worth based on fundamental analysis. The cornerstone of value investing involves looking at companies as a whole and forgetting about what the media and your neighbor says about certain companies. There’s a whole slew of profitable, solid companies on the horizon, and it just takes some time and energy toward figuring out which ones can earn a spot in your portfolio.
How to Implement Value Investing
Let’s walk through value investing steps from a beginner’s perspective.
Step 1: Focus on strong fundamental analysis.
Without complete and in-depth analysis, you can’t get a sense of which companies will offer safe and steady returns over time. While all of this information might scare away eager first-time investors, note that if you want to do value investing right, it requires a lot of research — you can’t just do a quick calculation and call it done. Here’s what the fundamentals can tell you.
Watch for Low Debt-to-Equity Rating
The debt-to-equity (D/E) ratio helps investors determine how a company finances its assets. It shows the proportion of equity to debt a company uses to finance its assets. Too much debt can be risky to investors, but remember that a high D/E ratio can still signal that a company is investing in additional streams of income or other positive outcomes.
The formula looks like this:
Debt to Equity Ratio = Total Liabilities / Total Shareholders’ Equity
Look for Positive Earnings Per Share Growth
Earnings per share (EPS) indicates profits, and to figure out how a company performs, you simply divide a company’s reported net income after tax, then subtract the company’s preferred stock dividends by its outstanding shares of stock. Here’s the formula for EPS:
EPS = Net Income – Preferred Dividends / Weighted Average Shares Outstanding
The higher a company’s EPS, the more profitable it tends to be, though a higher EPS doesn’t always guarantee a company’s success. Look for companies that are selling at bargain prices.
Check Out Price to Book Value
What does price to book value (P/BV) mean? The P/BV ratio is the ratio of the market value of equity to the book value of equity — the measure of shareholders’ equity in the balance sheet.
P/BV ratios are calculated by dividing the current price by the most recent book value per share for a company using the following formula:
Price to Book Value = Market Value of Equity/Book Value of Equity
Choose to invest in stocks selling near or below their book value.
Take a Look at PE and PEG Ratio
A stock’s price to earnings (P/E) ratio is calculated by taking its share price and divided by its annual earnings per share. A higher P/E ratio means that investors are paying more for each unit of net income, which makes it more expensive to purchase than a stock with a lower P/E ratio.
But look beyond just price and earnings and look at the historical growth rate of the company’s earnings using the P/E Growth (PEG) ratio. How do you do this? You take the P/E ratio of a company and divide it by the growth rate of its earnings, like this:
PEG Ratio = P/E / Annual EPS Growth
Look for a lower value by comparing two stocks using the PEG ratio.
The tried-and-true trick of PEG ratio: A PEG ratio of 1.0 or lower suggests a stock is fairly priced or even undervalued. A PEG ratio above 1.0 has historically suggested that a stock is overvalued. However, it’s important to remember that a company’s growth may not continue as it has in the past, so watch out for the fallacy that you’ve got an ironclad investment.
Do the companies you’re investigating pay dividends? A dividend is a sum of money paid, say, quarterly, by a company to shareholders out of its profits or reserve money. If you invest in a company that does pay dividends (not all do), you’ll reap the benefits while you’re waiting for everyone else to notice that the stock is a worthy purchase and subsequently becomes overvalued.
Step 2: Buy companies, not stocks.
Once you’ve decided on an undervalued stock, remember that you need to investigate all metrics, not just pick and choose the metrics that sound most promising to you.
In addition, you want to invest in well-managed companies, not stocks. You should like everything about the company you invest in and should never invest in a company you don’t understand.
Step 3: Invest and hold.
Next, identify the brokerage you want to use if you don’t already have a brokerage account, set up an account and investigate how much you’ll pay in fees. Buy the appropriate amount of stock among the good companies you’ve identified and hold onto your stocks for the long term.
Become a Student of Value Investing in 2022
It’s a good idea to identify your financial goals, and note that what you pay for a stock and what you earn initially might not be financially beneficial right away. You’ll have to give the company time to flip from undervalued to overvalued — think Amazon back in 1997.
By now, you may be thinking that determining the future performance of companies requires a lot of research — more time than you’re willing to invest. However, the payoffs can be extraordinary.