Published: April 21, 2005
Have you ever sat
back and tried to compile a list of the most successful investors of all
time? If you're like most investors, then during that process you
probably considered such names as Warren Buffett, Benjamin Graham, Peter
Lynch or John Neff.
While all of these great investors certainly had distinct approaches to
the market, they had one thing in common: They are all considered -- to
one degree or another -- to be value investors.
While momentum investors come and go and this year's hot mutual fund
manager fades into next year's chump, value investors like Buffett and
Lynch have shown incredible staying power over the course of their
careers. And although all of these great men certainly went through some
cold streaks on the investing front, we cannot think of another approach
that has proven to be more effective or reliable than value investing
over the long haul.
A wealth of academic research has
been published on this very subject, offering us some cold hard facts to
back up this assertion. For example, according research firm Ibbotson
Associates, from December 1968 until December 2002, value stocks
delivered an average annual return of +11.0%. By comparison, growth
stocks returned +8.8% and the S&P 500 managed a mere +6.5%
annualized return.
The
Russell Investment Group provides us with another great example. That
firm's widely followed Russell 2000 Index is also divided into two
sub-indices based on a host of fundamental criteria -- a Russell 2000
Growth and a Russell 2000 Value Index. In our chart, we've depicted the
growth of two $10,000 investments from mid-1995 through the end of the
first quarter of 2005; the first $10,000 was invested in the Russell
Growth Index and the second in the Russell Value Index.
What's clear is that for almost this entire period the Russell 2000
Value Index firmly outpaced the Growth Index. This was the case for all
but a few months surrounding the year 2000 top.
What's more, contrary to popular belief, our chart shows that value
stocks still delivered strong gains during the bull market of the late
1990s. And as we would certainly expect, value stocks handily
outperformed growth stocks throughout the bear market of 2000 to 2002.
(During times of economic uncertainty, investors traditionally flock to
quality value stocks for the safety and stability they provide.)
This is a perfect example of why focusing on value makes sense for most
investors. Hot momentum and growth stocks may come and go, but over the
long run value consistently wins out.
What is Value?
Before we go any further, we first need to get a better understanding
for what we mean when we use the term "value." In order to
grasp this important concept, we need to first take a step back and look
at what we're actually buying when we purchase a stock.
Some investors buy stocks because they offer compelling and enticing
stories -- a new potential blockbuster drug, an emerging technology or
an exciting new invention, perhaps. Meanwhile, others purchase stocks
primarily based on the value of their assets. However, when you purchase
a stock, it's important to remember that you're not buying a story, a
manufacturing plant or a bunch of equipment. At its very core, every
stock investment simply involves the purchase of a stream of future
cash flows.
Value investing isn't about purchasing stories -- it's about buying
stable companies with proven business models that generate consistent
annual cash flows. In addition, value investing is all about buying
these stocks for less than they're actually worth. In other words, value
investors look for situations where the future stream of cash flows a
company is likely to produce has been mispriced by the market.
Most value investors also use the
important concept of margin of safety when evaluating
investments. In doing so, they first use a variety of techniques to
estimate the true intrinsic value of several different companies. They
then invest exclusively in those firms that are trading at a sizable
discount to their estimated intrinsic value. By investing in this
manner, even if their estimates of a company's actual value prove to be
slightly incorrect, they should still manage to earn above-average
returns.
What Tools Can Investors Use to
Discover Quality Value Stocks?
Value investing is not easy. There is no
one magic bullet, no single metric that will allow investors to uncover
the best value plays quarter after quarter. However, my staff and I take
a number of factors into consideration when looking for good value
candidates. Here are just a few of our favorites:
Price-to-Earnings (P/E)
P/E-to-Growth (PEG)
Enterprise Value/Cash Flow
Price/Sales (P/S)
Return-on-Equity (ROE)
Operating Margins
How Do We Search For Value Stocks?
Unfortunately, there's no predetermined path that will
allow you to uncover the best value plays. Investing is always a
delicate balance of both art and science.
My staff and I frequently scan the market in search of stocks that we
believe offer compelling value. We do so by quantitatively screening for
companies that score well in the key valuation and profitability metrics
we identified above, as well as a host of other important fundamentals.
However, don't assume that a list of names that filter through ratio
analysis screening is all that is necessary to outperform the broader
market averages. Each stock generated by those screens needs to be
carefully evaluated, and a close examination of non-numerical data
should also be weighed.
Next, consideration should also be paid to the company's industry, as
well as whether or not the firm has a recognizable edge over its peers. My staff
and I always try to identify distinct and defensible competitive
advantages before recommending a company. These advantages could take
the shape of a powerful brand name, a unique product, or even a patented
technology. Remember -- companies with sustainable competitive advantages
are much more likely to maintain a high level of profitability over the
long haul.
It is also a good idea to determine whether a company operates in a
cyclical market. Some firms -- such as automakers -- typically see their
fortunes rise and fall with changes in the economy. The performance of
these firms is often tied to broad macro-economic factors; they may look
attractive when times are good, but they're also vulnerable to economic
slowdowns. In other words, ask yourself whether or not the company's
economic moat is wide enough to protect the firm's profitability under
difficult conditions.
Knowledge is power, and it is always important to know as much about a
prospective company's operations as possible. This includes a thorough
look at its industry, its vendors, its customers, its competitors, etc.
Digging through old press releases posted on financial websites like
Yahoo Finance is a good starting point. The company's most recent
quarterly and annual reports should also be required reading. However,
keep in mind that press releases written by a firm's investor relations
department will nearly always paint the company's prospects and results
in the most favorable light possible. Therefore, it is important to
balance that information with objective analysis from other sources.
Remember, the most valuable articles or bits of information can
sometimes run contrary to your opinion on a company. In other words,
don't fall prey to ignoring possible warning signs simply because they
challenge your thesis on a stock. Instead, try to poke holes in your own
arguments. This will help eliminate costly investing mistakes and will allow
you to invest with more conviction.
Successful value investing doesn't necessarily involve uncovering an
abundance of potential picks; the key is to be right when you do find a
good one. When you've finally made up your mind, invest with confidence
and hold for the long term.
With these points in mind, my staff and I have identified five solid
value candidates that fit almost all of our stringent investing
criteria. Here's a quick look at each of these firms...
Company #1
One of the world's largest and most geographically diversified gaming
companies, this firm operates top-tier casinos in nearly all of the
nation's premier gambling markets. Company earnings more than
doubled in the last quarter and reached well over $3.00 per share in the
most recent fiscal year.
To
find out the name of Company #1 and learn more about why it should make
a great investment in the coming years, please visit one of the links
below.
Company #2
With nearly 50 million accounts and $80 billion in managed loans,
this firm is a major
consumer lender and one of the nation's largest credit card issuers.
Thanks to its recent acquisition of a major regional bank, Company #2
has gained important access to a cheap source of funds to help support
its global lending operations. And with projected earnings of nearly $8
per share next year, the stock looks like an exceptional value play.
To
find out the name of Company #2 and learn more about why it should make
a great investment in the coming years, please visit one of the links
below.
Company #3
This company produces a line of shoes designed mainly for outdoor and
adventure enthusiasts. Thanks to its strong brand name recognition in
this rapidly-growing market, the firm is able to sell its popular
products at premium prices. As a result, company earnings are expected
to soar to over $5.00 per share next year. The firm is also a prodigious
cash generator, delivering operating cash flow growth of over +50%
annually throughout the past three years.
To
find out the name of Company #3 and learn more about why it should make
a great investment in the coming years, please visit one of the links
below.
Company #4
One of the world's largest beverage producers, this firm charges premium
prices for its well-known brands. Going forward, the company is poised
to deliver strong gains by expanding aggressively in international
markets like China and India. This firm also wins points for being
one of the most cash generative companies on Earth -- the company pulled
in nearly $6 billion in operating cash flow over the past year. After
watching the stock fall steadily over the past few years, we believe
Company #4 is now showing all the signs of a classic value stock.
To
find out the name of Company #4 and learn more about why it should make
a great investment in the coming years, please visit one of the links
below.
Company #5
This company, which focuses primarily on the market for high-performance
running shoes, boasts an extremely loyal customer base throughout the
country. The firm's high-performance product lines carry fat profit
margins, enabling the company to deliver earnings of more than $1.50 per
share. And although the firm is growing at twice the rate of its
competitors, the stock now trades at a steep discount to the industry
average.
To
find out the name of Company #5 and learn more about why it should make
a great investment in the coming years, please visit one of the links
below.
Important:
To view the remainder of this article, in which StreetAuthority.com
founder Paul Tracy and his staff provide company names and in-depth
profiles for all five of the stocks highlighted above, you'll need to subscribe to
our premium Market Advisor newsletter. Please visit one
of the following links to continue...
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