One of the sweetest and most profitable pleasures of successful investing is to buy high-quality “value stocks” (or stocks that are reasonably priced, if not cheap, in relation to its sales, earnings or assets), then hold on to them as mainstream investors recognize the value and push up the share price.
Value stocks are stocks trading lower than their financial fundamentals suggest. They are perceived as undervalued, and have the potential to rise. Many new tech stocks, for instance, start out as growth stocks and transition into value stocks.
They have a low price-to-earnings and price-to-book ratios—which is why they’re less expensive than growth stocks. Due to this fundamental distinction, a value stock is often traded at a more affordable rate than a growth stock.
To investors, they see companies that fall into this category as undervalued. These investors are less likely to invest in a growth stock because they feel that value company’s stock will eventually reach their full potential once they are recognized by the market.
Generally speaking, the climb is steady for value stocks. The only other way for it to emerge into the market like a growth stock is for it to be a bit more innovative with its products or services.
Pat McKeough is an expert at delving into a company’s financial statements and identifying undervalued securities and value stocks. That’s because value stocks are the foundation of any long term investment strategy, at TSI Network we also recommend our three-part Successful Investor strategy:
Invest mainly in well-established companies;
Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
Downplay or avoid stocks in the broker/media limelight.
Do you have a sound value investment strategy? If not, follow our tips below.
At the core of the value investing approach is identifying underpriced, but well-financed companies that are well-established in their businesses and have a history of earnings and dividends. They are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does. Value investors have long-term mindsets when it comes to investing.
Here are some key factors in a sound value investment strategy:
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How to profit from human nature with a value investment strategy
It’s best to put yourself in a position to profit from human nature, rather than suffering because of it, as you often do in high-risk investing. Here are two rules to follow:
Take advantage of spinoffs, which you may get when a company’s managers put the interests of shareholders ahead of their own: A spinoff occurs when a company sets up one of its divisions as a separate corporation, and hands the stock out to its shareholders as a special dividend. That reduces the company’s asset base. That leaves less total corporate income to pay for management compensation, so it works against the immediate interests of management. However, it seems to work in favour of investors’ interests. Numerous studies show that over a period of years, spinoffs tend to perform much better than comparable non-spinoff stocks.
The effect extends to the parent companies—those that carried out the spinoffs. They also tend to outperform comparable companies that have not carried out spinoffs. It goes to show, at least in this case, that striving to settle conflicts in favour of customers can pay off for companies in the long run.
Pay attention to stock buybacks in a value investment strategy: When a company buys back its own stock in the market, it tends to serve the interests of its shareholders in two ways. First, it raises the company’s per-share earnings (because there are fewer shares outstanding among which earnings are divided). Second, buybacks tend to bid up a company’s share price.
You might also say that buying stock back substitutes a capital gain for the dividend income you might otherwise have received if the company had used the money to pay dividends instead of buying back shares. That’s irrelevant in registered accounts such as RRSPs. But in your personal account, you may pay a lower rate of tax on capital gains than on dividends.
In any event, you are generally only liable for capital-gains taxes when you sell. You decide when that is, and you can time the sale to suit your own needs and tax situation. The longer you put off selling and paying taxes, the longer those deferred tax dollars can generate additional investment income for you. In contrast, you are liable for taxes on dividends in the year when the company chooses to pay the dividend.
Buying stocks on margin has tax advantages for a value investment strategy
When you buy on margin, you’ll be able to write off your margin interest in full against ordinary income in the current year. However, you’ll pay less than ordinary income tax rates on dividends from Canadian stocks, thanks to the dividend tax credit.
Above all, you’ll defer all capital gains taxes until you sell, and only pay taxes on capital gains at half the rate you pay on ordinary income.
Hidden assets are the key to spotting value investment strategy picks that are ripe for a takeover
A value stock pick’s takeover prospects are just one thing we look at when we choose companies to recommend in our newsletters and investment services. An equally important part of our investment approach involves looking for companies with what we call “hidden value”—hidden or widely overlooked assets.
By hidden value, we mean valuable assets that are not getting the attention they deserve from investors. When a company’s assets are wholly or partially ignored or hidden, the stock trades for less than it’s really worth, so you get to buy at a bargain price.
Companies that launch takeovers also tend to look for hidden assets. That’s why so many of the value stock picks we recommend get taken over. Of course, hidden assets are no guarantee of a takeover, but they cut long-term risk, and make a takeover a lot more likely.
If a stock with hidden assets gets cheap enough, it attracts buying by value-oriented investors. Its low price may also trigger a takeover that otherwise might never have happened.
What do you consider hidden value that we haven’t mentioned here?
Do you have a sound value investment strategy? If not, follow our tips below.
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