Value Investing: What It Is and What to Buy
If you're trying out various investment approaches to see which fits you best, be sure to give serious thought to value investing. It's favored by many of the most successful investors, including Warren Buffett.
Value investing involves seeking out stocks that are selling for less than they're worth. By doing so, you're building in a margin of safety that can reduce the stock's downside risk.
Of course, figuring out what a company is worth is much easier said than done. The simplest of measures that investors use to get a handle on a stock's valuation is its price-to-earnings ratio, or P/E. The lower the P/E, the more attractive the stock -- in general. It's important to remember that P/Es vary by industry, so a car stock might be a bit pricey with a P/E of 16, but a faster-growing software company could be attractively priced with a P/E of 16. Keep in mind, too, that if a stock falls for good reason, its P/E will drop. Not every low P/E signals a bargain, and some companies with seemingly steep P/Es can be great values. The more you learn about a company, and the more measures you evaluate, the more effective an investor you're likely to be.
Note, too, that value investing is often contrasted with "growth investing," which chases fast-growing stocks and big gains. That can work out well, but there's often little margin of safety. And besides, it's not as if value investing avoids growth. Ideally, a company can grow at a good clip and also seem undervalued.
Value investing portfolio candidates
So which stocks deserve consideration from a value investing point of view? There are many, but below are a few that The Motley Fool's CAPS stock screener brought up when I sought stocks with market caps higher than $500 million, P/E ratios below 20, and three-year average revenue growth rates of 6% or more. You should, of course, do more digging before buying any of them.
Cirrus Logic , which makes circuits, has been a major supplier to Apple, which is both a good thing and a bad thing. Apple's successes have driven growth at Cirrus Logic, but the dependence has also left it vulnerable, leading to rather high short interest. Some worry about Apple offering lower-priced goods, which could put pressure on Cirrus' profit margins. Cirrus has been lining up other customers, though, and also operating in other realms, such as LED light power controllers. During the past three years, Cirrus Logic's revenue has averaged annual growth of 31%. Earnings have averaged a 3% drop, but during the past year, they jumped by more than 50%. The stock's recent P/E ratio has been around 10, well below its five-year average of 17, making some see it as an appealing value-investing pick despite its risks. Cirrus Logic reports its latest quarterly results on Friday.
Micron Technology is another candidate for the value investing devotee. Its second quarter featured revenue roughly doubling and costs falling. With demand growing for solid state drives (SSDs), bulls like the company's investments in NAND memory technology, and see demand for 3D NAND technology driving growth at Micron and elsewhere. With a forward P/E near 10, my colleague Anders Bylund has dubbed Micron "a high-octane growth stock, but priced like a sleepy value play." Micron Technology hasn't paid a dividend since the 1990s, but with its current strength and growing profit margins, some are looking for a dividend reinstatement. Even without a dividend, though, the company is rewarding shareholders via aggressive stock buybacks.
Universal Display is another stock that value investing aficionados should consider. Its OLED technology is found in millions of smartphones, tablets, and TVS. Evolving technology (think curved OLED displays and transparent OLED displays) is likely to keep demand high. Its fourth quarter featured revenue up 76% and earnings nearly tripling over year-ago levels. The company's stock has been volatile, but its P/E ratio near 19 (well below its five-year average of 119) makes it an appealing value-investing opportunity.
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The article Value Investing: What It Is and What to Buy originally appeared on Fool.com.Selena Maranjian, whom you can follow on Twitter, owns shares of Apple. The Motley Fool recommends Apple and Universal Display. The Motley Fool owns shares of Apple, Cirrus Logic, and Universal Display. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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