These stocks may not be sexy, but could they be the key to success in the stock market? The pros and cons of value investing

As the strategy of choice for many of the world’s top investors, including Warren Buffett, everyday Aussies are now finding the true value of these stocks versus what are considered riskier options like growth stocks.

For new investors starting their investment journey in 2021, here’s a look at value stocks and why it might be a good time to invest in companies with inherent value.

What are value stocks and value investing?

Value stocks are companies with stock prices that are lower than their fundamentals suggest. Some examples of popular value stocks are Target, Johnson & Johnson, and JP Morgan.

Value investors view these stocks as if they were on sale. They identify companies with low prices and high potential, buy those stocks and then profit when other investors eventually realize what they are missing and buy in at higher prices.

When it comes to an investment strategy, value investing is a long-term, conservative investment approach. When investors invest in value stocks, they ideally want to buy and hold companies whose stock prices are currently below their intrinsic value.

These value investors analyze metrics such as performance, profit, revenue, cash flow, price / earnings ratio and a variety of other financial information, such as the CEO’s vision for the company.

The strategy of investing in value stocks was developed in the 1920s by Benjamin Graham, better known today as the “father of value investing”. In addition to being Warren Buffett’s mentor, Benjamin Graham wrote The Intelligent Investor, which has been recognized as a fundamental work in value investing.

The pros and cons of value stocks

Like most types of stocks, value investing has many advantages and some disadvantages that investors should be aware of before considering adding it to their investment portfolio.

The first benefit is that value investing is less risky and volatile than most short-term investment strategies. Why? Since investors don’t buy stocks today and sell them tomorrow, they don’t necessarily have to catch up with daily price fluctuations.

Value investing can also produce spectacular returns as an underrated asset can reveal its true value and bear fruit because market participants are not pessimistic.

Value investing is an ideal way to harness the power of compounding. Compounding is when people reinvest the returns and dividends generated from value stocks, their profits grow significantly over time, and their profits eventually begin to generate their own profits with minimal additional effort required.

With advantages, there are also disadvantages.

The biggest is that an undervalued stock can take a long time to return to its inherently fair price, and value investors may have to hold their positions for years before market sentiment changes in their favor.

When interest rates fall and corporate profits rise, growth stocks tend to outperform value stocks. In this scenario, investors are willing to pay a premium for growth stocks. Because most value stocks are cyclical, they typically do well on economic rallies but lag behind in bull markets.

Is Now the Best Time to Buy Value Stocks?

Until recently, growth stocks were king of the investment world due to a rare coincidence of events (between 2017 and 2020). These included the wave of technological innovations highlighted by the advent of cloud computing, as well as the accelerated adoption of e-commerce and the migration to mobile devices. These events took growth stocks to new heights.

While the rise in value stocks was driven not only by the global pandemic, but also by the unprecedented fiscal and monetary stimuli that have allowed the US economy to recover from the virus-induced recession much faster than expected.

Even so, the overall outlook for value investors is still somewhat positive. Cyclical sectors are in focus due to the strong recovery in most economies around the world and many investors are rotating out of growth stocks and diversifying into these sectors for returns.

Value stocks have virtually fallen out of favor for many years as most investors have focused on other types of stocks. We are now seeing investors picking up on value stocks with cheaper valuations after a difficult 2020.

Josh Gilbert, Market Analyst, eToro

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These stocks may not be sexy, but could they be the key to success in the stock market? The pros and cons of value investing

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Last updated: July 6th, 2021 Published: July 6th, 2021

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