Glossary · Stocks and markets
Value stock
A value stock is a share that trades at a low price compared with the company’s profits, assets or dividends, often because investors expect little from it.
Also called: value investing, value shares, cheap stocks
In plain words
At a yard sale you spot a lamp worth $100, priced at $60 because it is dusty. If it works, you got a lot for your money. Value investing hunts for the stock-market version: companies whose shares are priced low compared with what they earn or own.
A value stock has a low P/E ratio, a low price-to-book ratio or a high dividend yield. Usually it is a mature business (a bank, an oil company, a steelmaker) that investors find dull or worrying.
The idea goes back to Benjamin Graham, who taught it at Columbia University from 1928 and wrote “Security Analysis” (1934, with David Dodd) and “The Intelligent Investor” (1949). His most famous student is Warren Buffett.
Example
Cheap for a reason?
- Steel Co. earns $5 a share and its shares cost $40: a P/E of 8, an earnings yield of 12.5%. Say the market as a whole trades at a P/E of 20.
- If its profits just hold steady, the low price leaves room for a good return: the dividends, plus a price that may drift up toward a more normal P/E.
- If its profits are about to halve because steel prices are falling, the P/E on next year’s earnings is 16, and the stock was never cheap.
A low price is good value only if the profits behind it last. When they do not, it is called a value trap.
One level deeper
Graham’s central idea was the margin of safety: buy only when the price is well below a careful estimate of value, so that mistakes and bad luck still leave you whole.
In academic research, “value” usually means a high book-to-market ratio, the inverse of P/B. Studies by Eugene Fama and Kenneth French found that such stocks earned more than growth stocks over most of the 20th century, a pattern known as the value premium. It shrank or reversed in the 2010s, and economists still debate whether it was a reward for risk or a mispricing.
Value stocks have tended to do well when the economy recovers from a slump and when interest rates rise, and to lag when investors chase fast growth.
Why it matters
It is one of the two big investing styles, with growth; many funds and indexes are labeled one or the other.
It is a discipline: compare the price with what the business earns and owns, not with how exciting it is.
The long debate over the value premium is one of the central questions of finance research.
A common mistake
Myth: A stock that has fallen a lot is a value stock.
In fact: A falling price makes a stock cheaper only if the company’s profits and assets hold up. Many shares fall because the business is shrinking, and then a low P/E is a warning, not a discount.
Questions people ask
What is an example of a value stock?
Typically large, mature companies in banking, energy, industry or consumer staples that trade at low P/E or P/B ratios. Which companies count changes as prices change; index makers reshuffle their value and growth lists regularly.
Does value investing still work?
Value lagged growth for most of the 2010s and has had good and bad stretches since. Over the very long US history it did better on average, but with long periods when it did worse.
Who is the most famous value investor?
Benjamin Graham, the father of the method, and his student Warren Buffett, who added a taste for great businesses at fair prices to Graham’s hunt for cheap ones.
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About the numbers
- This page explains a term. It is not investment advice.