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Answer:
Dear J. Schwartz,
The
Definition
Value
investing means buying a stock at less than its intrinsic
value. To be more specific, a value stock is one that
has not been correctly "valued" by the overall market
and therefore its price is lower than it should be,
given the true assets of the company.
This
investing philosophy was established years ago by
Benjamin Graham and David Dodd, both professors at
Columbia University. Today, its most famous practitioner
is Warren Buffett.
Why
Is a Value Stock a Value Stock?
There
are various reasons why a stock is lower in price
that it theoretically should be.
(1)
First of all, it could be that the entire industry
sector is currently out of favor or even out of fashion
and therefore, a perfectly well run company is tainted
by association.
(2)
It might be that it's had one or two quarters
with declining profits and even though its products
(or services) are of high quality, the company is
not currently looked upon with favor.
(3)
Another possibility involves change in leadership.
Perhaps the board of directors fired the president
of the company and an interim president is temporarily
handling the affairs of state. Or, if a new president
has taken over the reins, he or she has yet to turn
around the company, heal its ills, and bring it back
into favor.
(4)
Finally, when a company reduces or cancels a dividend,
it can fall into the value stock category.
Those
who are into value investing look for this type of
stock believing that before too long the institutional
investors as well as the general public will see the
company's true value and when that happens, the stock
will go up in price.
More
often than not, a value stock will not be widely known
and perhaps even a little dull; it's not likely to
be a glamorous stock, although there certainly are
exceptions to this generalization.
Note:
In many respects, value investing is ideal for the
BUYandHOLD investor because it typically involves
long-term holding of a position before profits are
realized.
Finding
Value Stocks
To
participate in this type of investing, you need to
focus on the company's financial picture, not just
on a low stock price. In other words, the company
should have both current or potential high
earnings combined with a low stock price. As you undoubtedly
know, one way to measure this combination is through
earnings per share. You can quickly calculate
EPS by taking the net earnings and divide that
by the outstanding shares. Do this for a number of
stocks within the same industry. A high EPS is often
indicative of a value stock.
Another
indicator of a value stock is its assets. Does
it have a high book value? If so, it's quite
likely that its stock will eventually go up in price.
You
can find both yardsticks for over 1,000 stocks in
Value Line Investment Survey, (www.valueline.com),
the monthly independent research service.
If
you're interested in delving deeper into this approach
for buying stocks, I recommend reading Value Investing:
From Graham to Buffett and Beyond by Bruce Greenwald
(and others), published by Wiley. It's a fascinating
and quite easy to read book.
Good
luck!
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