Value Investing

Value investing is another one of the well-known methods of stock picking. This post will provide the reader with a general discussion concerning certain characteristics associated with value investing. This post is not designed to be complete in all material respects. It is being provided for educational purposes only and should not be considered as legal or investment advice. If you have any questions about value investing, you should contact an experienced professional.

Value investing requires the investor to look for stocks with strong fundamentals, including earnings, cash flow, book value and dividends, selling at lower than expected price given their quality. Put another way, a value investor is seeking to buy stocks that are trading at a discount to their net asset value and hold them until they became fully valued. To be a value investor, profits are made by investing in quality companies, not by trading. As such, value investors generally pay no attention to external factors affecting a company, such as market volatility or day-to-day price fluctuations absent exceptional circumstances.

As with most other analytical methods, fundamental analysis is part and parcel of value investing. However, there are no set parameters associated with this type of investing.

In this post, we are focusing on one of if not the most important fundamentals of all — earnings and profits.

As it relates to the financial condition of a company, there are a few key terms and ideas that investors need to know. They include:

The terms “sales” and “revenue” are interchangeable; they both refer to the gross amount of money brought in from business operations regardless of cost, liabilities, etc. This is what is known as the company’s top line. It is used as a measure of the overall growth of a business.

Profit is the amount of money a company earns during a given fiscal period. It is calculated by subtracting from revenue all the costs incurred during the fiscal year. Profit is what is left after all the company’s expenses have been paid.

Profit is the true measure of success of the business. It reflects how much money a business generates for the stockholders. It is a measure of return on equity and return on assets.

The operating margin is equal to operating income (earnings before income taxes and interest payments) divided by total revenue. It is used as a gauge for the earning power of a business.

Profit margins are important to the value investor because it can help gauge what it costs the company to make money. To find the profit margin, take the profit (after taxes) for the fiscal year and divide it by revenue. Companies with higher profit margins generally have to invest less capital back into the business to make money.

Earnings-per-share (or EPS) are reported in two forms — one identified as basic and the other diluted. Basic EPS is calculated by divided reported net income by the average weighted shares outstanding. Diluted EPS is an adjusted number meant to show how much each share would have earned if the total number of shares outstanding increased due to stock options and convertible debt.

The price-to-earnings ratio tells an investor how much money he is paying for $1 of the company’s earnings.

Value stocks can be found trading on any exchange located in any industry. However, as with all types of investment strategies nothing is guaranteed. All of the above factors and others too numerous to be set forth herein are subjectively considered by investors differently. It is for this reason that you might want to consider a professional to assist you in this type of investing.