With markets a bit overheated after two years of 20%-plus gains, it is a good time to look for value stocks. What are value stocks? Broadly, they are stocks that are trading below their intrinsic value, for whatever reason. It may be due to broader macro issues in their sector or industry, lack of exposure, mismanagement at the company, or some specific event that hurt the stock price, among many other reasons.
A good value stock is one that is poised to bounce back and be recognized for its value. A value trap is a cheap stock that is discounted for a reason and probably won’t amount to much anytime soon. To find a good value and avoid a value trap, here are five things that investors should look for.One of the major value factors to consider is the P/E ratio. The P/E ratio is simply the share price relative to its earnings over the past 12 months. A lower P/E may suggest that the market has not recognized the stock’s value relative to its earnings. A high P/E suggests that there may be more enthusiasm about the stock than its earnings would indicate. Benjamin Graham, the father of value investing, said a P/E of 9 or lower was a value stock. But a lot has changed in the past 75 years, so there is some flexibility there. The average P/E ratio is generally between 20 and 25, so you can use that as a guidepost. But a P/E ratio should be viewed relative to industry peers, as well as a stock’s own P/E history. If a stock has historically traded at a P/E multiple of say 25, and is now trading at 15 times earnings, that might be considered a value.The forward P/E and PEG ratios are forward looking metrics. The forward P/E looks at the P/E ratio 12 months out, based on anticipated earnings. The PEG ratio is the P/E ratio divided by expected earnings growth over a certain time period. Typically, the PEG is calculated five years out. The PEG may be the best indicator for an undervalued stock, as it factors in expected earnings growt
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