Growth stocks have outperformed value style equities for some time now, but there are rumours brewing value investing to stage a comeback. But to be a successful value investor, you have to be able to differentiate undervalued equities from value traps.
That’s especially true in the current UK environment, with a number of cheap-looking companies having seen further falls. Just this year, we’ve seen big share price drops from Debenhams (DEB), Capita (CPI), WPP (WPP) and ITV (ITV).
Brexit is in part to blame, but so too are the companies themselves. Carillion was a case in point – declining profit margins and excessive leverage did the outsourcer no favours.
Some of these cheap companies will pique the interest of value investors. In fact, Steve Magill, head of UBS’s European Value team, says his “natural hunting ground” is in areas where we’re seeing profit warnings. Though, he adds: “We’re trying to finesse our timing because we do know that where you have one profit warning, you’ll have many profit warnings. But that’s a time of opportunity.”
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In this post I will present a simple 8 step fundamental analysis template which can be used to analyze if a a stock is investment-worthy or not.
For any stock to merit investment, the most important thing is the financial stability of the business. It is important that a company has manageable debt levels and generates enough operating profits to easily pay interest on its loans and has sufficient cash for day to day operations while delivering decent growth in revenues and profits.
I use the first four ratios described below to assess the financial stability of a company when i consider investing in its stock.
- Long term Debt/Equity Ratio –
Debt/Equity Ratio is a debt ratio used to measure a company’s financial leverage, calculated by dividing a company’s total liabilities by its stockholders’ equity.
Companies (excluding financial institutions) with D/E of less than 1 to be stable and can easily cope with short term downturns as they have higher reserves than what they have borrowed.
D/E= Sum of non current debts/Shareholder Funds.
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The original post is by Mastermind, Megabaggers and appears here.
I find it ironic that more research is being done today than at any point in time in the past, yet a lot of value investors are failing to beat the market.
Ironically, the mountain of articles on popular investing websites just aren’t helping. Part of the problem might be due to the “more brains” problem Graham cited years ago. Since everybody on Dalal Street is so smart, all those brains ultimately cancel each other out.
This glut of brain power, investment research, and investors clamouring for bargains does not mean that you can’t beat the market. But, knowing how to pick value stocks is a key requirement, along with having a good strategy and being prepared to do things that most other investors aren’t.
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