When it comes to buying stocks, there are typically two big-picture strategies you can choose from – growth investing or value investing.
The idea of growth investing largely speaks for itself. Simply put, you invest in companies growing their sales and profits at impressive rates. But does that mean value investing involves companies that aren't growing? And how is this strategy better or worse?
If you're wondering what value investing is, you're not alone. Thankfully, the basics are pretty easy to understand even for novice investors.
What is value investing?
Value investing doesn't mean you're buying a stock that has zero growth. It just means that growth isn't the main appeal. Instead, you're investing in a company that is likely to be underpriced and overlooked when compared with its flashier rivals.
Maybe the value stock in question isn't seeing massive expansion, rather it delivers a predictable stream of earnings and pays consistent dividends as it hums along. Or maybe the company has been severely punished by Wall Street after falling on hard times, creating a bargain opportunity.
Or perhaps it's just plain boring, like a publicly traded utility stock or a small and specialized chemical manufacturer, and nobody is even paying attention.
Whatever the case, value investing is usually about finding hidden gems rather than chasing flashy companies everyone else is talking about. The appeal isn't popularity or future growth projections, but rather the current underlying value of that business right now.
What is an example of a value investment?
To illustrate what value investing is with a practical example, let's look at the iconic industrial stock GE Aerospace (GE), which changed its company name from General Electric following the recent spinoff of GE Vernova (GEV).
The firm has seen tepid growth in recent years. But look at GE stock, which nearly doubled in 2023 and is up about 60% in 2024. Clearly, investors see something in this company – and what they see is its underlying value.
Wall Street was overly negative on GE after a few bad years and wound up overselling the former Dow Jones stock. The company has been working on a multiyear turnaround plan, including the spinoff of both its healthcare and renewable energy businesses. And things are looking up even if GE is less dominant than it was in decades past.
But GE didn't have to be a booming growth stock to make its investors money. It simply needed to be overlooked and undervalued.
How do I find the best value investments?
There are a host of big-name value investors on Wall Street who made a name for themselves by looking for hidden gems like GE. Just a few of the more prominent ones include Berkshire Hathaway (BRK.B) chief Warren Buffett and economist Benjamin Graham, who many consider to be the father of value investing.
So what made these icons so successful, and how did they find the best stocks to buy for value investors?
There's never a sure-fire formula for any investing strategy, but a few of the metrics that value investors like Buffett and Graham closely monitor include:
Debt-to-asset ratio. Value investing prioritizes companies that have modest debts backed by much more substantial assets. Not only does a low debt load provide stability, it also tends to prove management is responsible and has restraint. Generally, a debt-to-asset ratio of 1 or less is very attractive as it means those debts are covered.
Price-to-earnings (P/E) ratio. Bigger companies obviously have bigger profits. So it helps to normalize the raw numbers by breaking down those profits into earnings per share and then comparing them against the company's current stock price. This allows for "apples-to-apples" comparisons between stocks. Right now, the average P/E ratio of the S&P 500 is about 25, though some industry groups have averages moderately higher or lower than that figure.
Dividend yield. Dividends are regular profit-sharing payments to shareholders. A company's dividend yield takes the total payments you get over 12 months and presents that money as a percentage of your initial buy-in. As you can imagine, getting a piece of your investment back regularly is a very attractive proposition to many folks.
There are many other financial metrics out there that matter to value investors, but this list is a good start if you're interested in using value investing strategies as part of a well-rounded portfolio.
While growth investment may get all the attention, value investments can still deliver under the right circumstances.
