Bargain hunting
Value investors hunt for bargains using a variety of metrics. Our analysis starts by seeking stocks selling at low prices relative to their net worth. That’s why we favour companies with low price-to-book-value ratios (P/B).
The ratio compares a firm’s market value to the amount of money that could be theoretically raised by selling its assets at their balance-sheet values and paying its debts. A low P/B indicates you’re likely buying a company at a discount – or at least for a reasonable price.
Assets are one thing, but profits represent the beating heart of an enterprise. That’s why we reward profitable companies that trade at relatively low price-to-earnings ratios (P/E). The ratio is a staple for value investors, which has worked well for decades.
We also desire companies that use their capital wisely, which leads to a stock’s return on equity (ROE). ROE is a common measure of business quality and it indicates how much a firm is earning compared with the amount its shareholders have invested.
Finally, we appreciate companies that have enough money to buy back their own shares. We particularly like those that have reduced their share counts significantly over the past four quarters. After all, a well-executed repurchase program can provide a big boost to shareholders when companies trade at bargain prices and have cash to spare.
Value stars are awarded by combining all of the value factors, with the top 10 per cent (or 25 stocks) getting a full five out of five stars.
The five-star value portfolio gained an average of 15.2 per cent annually from the end of 1999 through to the end of November, 2023, when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly. In comparison, the market index gained an average of 6.5 per cent annually over the same period in the back test.
Value stocks can usually be held for months, and often years, with good success. The approach’s longer-term nature can be seen when the portfolio is rebalanced annually, which resulted in average annual gains of 15.3 per cent from the end of 1999 to the end of 2022. The market index climbed by an average of 6.4 per cent a year over the same period.