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Are Value Stocks Good Investments?

03 Dis 2021

Are Value Stocks Good Investments? | VI
(c) Sadie Xiao

We often compare value stocks to marked-down items we add to our 11.11 and Black Friday carts. Still, we ask if value stocks are good investments.

For starters, we also would like to ask why you’re buying the products in your cart. Are they worth their prices?

Now before we go deeper into this shopping analogy, let’s have a recap on what exactly are value stocks and why they differ from growth stocks. Then we’ll answer your big question: Are value stocks good investments?

Value stocks defined

Berkshire Hathaway [NYSE:BRK.A] [NYSE:BRK.B], McCormick [NYSE:MKC], Johnson & Johnson [NYSE:JNJ], and Procter & Gamble [NYSE:PG] are the most popular value stocks today. What makes them value stocks? Or an easier question could be: What do they have in common?

Well, yes, they are companies you surely know because they’ve been around for quite a while and you’re most probably their customer.

Usually, the first metric to identify value stocks is whether they are a mature business. But the ultimate criterion for the value stock category is whether or not the share price is lower than the stock’s intrinsic value. And yes, that’s why we often compare value stocks to items on sale.

See also: How Investors Make Money in a Bear Market

Value investors look for stocks that have a higher value vis-à-vis their current trading price. They want to buy a share in a company with great growth potential even though it’s not reflected in its share price. This way, value investors make money even as early as when they buy the stock.

However, similar to how you carefully assess which items to add to your cart for the sale (and we hope you don’t just consider the price but also the value the item will give you), you also need to assess which stocks have good, if not excellent, value.

And we have a method to evaluate whether a stock is undervalued (meaning with a higher value than its price) or overvalued (or with a higher price than its value). Should you be interested to learn more about assessing a stock’s valuation, you're welcome to join our free masterclass.

Value stocks vs growth stocks

We’re pretty sure you’ll ask to contrast value stocks and growth stocks, so we better include it here.

We have already given an overview of value stocks in the above paragraphs, so we’ll define growth stocks here. Growth stocks (which you’ve already probably deduced from the term itself) are those that have been registering excellent earnings growth in recent years. They are often expected to have above-average growth.

The best examples of growth stocks include Amazon [NASDAQ:AMZN], Square [NYSE:SQ], Facebook [NASDAQ:FB], and Netflix [NASDAQ:NFLX]. If you know these companies (and of course you do), you know their earnings have been shooting up despite a crisis like the pandemic.

See also: Investor Does Fundamental Analysis on Netflix

If you think about it, the easiest distinction between the two is the time element associated with their growth. Value stocks have established a history of strong earnings growth, whereas growth stocks are yet to draw a consistent growth line of their earnings.

Another difference between the two is the price you pay when you buy them. Value stocks are often under-priced or undervalued. Growth stocks, however, are priced higher. But why do people buy them then? It’s because they expect to have higher returns for when they sell them.

With the above said, are value stocks really good investments?

Should you invest in value stocks?

Yes, investing in value stocks will give you an advantage in the stock market for several reasons.

1. Value stocks are less volatile than growth stocks

Because value stocks have already proven their growth potential over the years, as evident in their stable revenues and earnings, they are less susceptible to market volatility.

Take Johnson & Johnson, for instance. The company’s performance throughout the years has been consistent and we can expect it to still perform the same (especially considering its business model and economic moat) in the next decade.

Growth stocks, however, come with higher risk as the stock price can easily spiral downwards with even the slightest negative news concerning the companies/industries.

2. Value stocks usually give you dividends

Value stocks, as they’ve been present and getting earnings, typically give out dividends, which can be a stable source of passive income for value investors. The dividend payout you receive is different from the capital gains you’ll get once the stock price finally gets aligned with the value.

Do note, however, that some value stocks don’t give out dividends and some growth stocks do (although the majority does not yet since they are still growing and would rather reinvest whatever earnings they get into their growth rather than provide stockholders dividend payouts).

3. You make a profit when you buy value stocks

Because value stocks are priced lower than what they’re worth, value investors make money just by buying shares.

Eventually, when the general market realises the full potential or the full value of the stock, they’ll buy the shares causing the price to go higher. By that time, value investors would have already made profits.

This is why value investing works best for long-term investors. As they often say, growth stocks might win the short-term battles, but value stocks win the long-term war.

So, what now?

One important thing to note before you put all your money into value stocks is that growth and value stocks complement each other. The former gives you short-term gains and assure you have good stocks you can sell in case you need cash. The latter makes sure you’re covered for the long term.

Just as how you have on your cart a product that’s not on sale because you believe it is a good investment nonetheless and how you wait for an item’s price to drop because you don’t want to overpay, include a variety of stocks in your portfolio to get more diversification and reduce investment risks.

Learn more about value stocks and value investing through this free webinar.