Value Stocks Topping the Market: The Vanguard Value ETF Example
Firms that are considered as ‘value stocks’ have a market valuation that appears to be rather understated considering important yardsticks like revenue, dividends, company and market growth trends, and even free cash flows. Investors often find these stocks appealing due to their price, which tends to be somewhat lower relative to their inherent worth. A general trend observed among these stocks is their performance capability, which often surpasses that of the market in totality. Among the many companies that fall under the umbrella of ‘value stocks’ are Procter & Gamble, Johnson & Johnson, and Berkshire Hathaway – all renowned names with large market caps, making them lucrative options for investors.
An integral representative of value stocks, Vanguard Value ETF (VTV) has proven itself by outpacing the market at large. Over the past year, it has yielded investors a return of 32.19%, which stands in stark contrast to the S&P 500’s total returns of 31.27%. This broad spectrum of performance has been observed during the week of October 25, 2021, against a backdrop of falling company valuations owing to scares of inflation and supply chain bottlenecks across various sectors of the economy.
A crucial factor to consider while seeking such ‘value stocks’ is a relatively low Price-to-Earnings (P/E) ratio. This ratio acts as a gauge displaying the expensiveness of the stock relative to its earnings. It can be computed by dividing the price of the stock by its per-share earnings. Value investors generally peg their interests in stocks that offer a low P/E ratio, ideally 15 or lesser. These ratios, however, should not be compared solely against the market, but also in relation to the industry norms. For instance, as of June 15, 2021, the average P/E ratio for the S&P 500 was recorded to be 45.11.
Another significant metric used in stock valuation is the Price-to-Book (P/B) ratio. It compares the market valuation of the company to its actual book value (total tangible and intangible assets minus total liabilities). This ratio adds another layer of sophistication to value investing. Good investment opportunities tend to present themselves in the form of P/B ratios that are less than one, indicating the market value is lower than the book value. However, while favourable, it’s essential to remember these ratios aren’t foolproof and are typically used in combination with Return on Equity (ROE). An acceptable ROE for value investors is usually in the vicinity of, or exceeding, 15%.
Even the most successful of businesses can meet their downfall if they are heavily burdened with debt. Excessive debt acquisition, particularly when the economy is flourishing and finances are readily available, has led to the downfall of numerous industry giants. As a result, it’s critical to consider a company’s Debt-to-Equity (D/E) ratio, which reflects its financial leverage. It’s recommended that value investors seek out companies with a D/E ratio below 2.0, with those less than 1.0 being the most desirable.
Value investors are usually in the game for the long haul, with their investment sensibilities primed to partake in the business’s long-term growth. Their share in the company’s profits, aka the dividend, plays an integral role in this investment strategy. But for it to make sense, these dividends must be sustainable. During previous market downturns, numerous firms drastically reduced their dividend payouts or suspended them outright, leading to shaken investor confidence. Thus, a prudent rule of thumb for these investors is to seek a dividend payout ratio less than 50%. However, in more defensive sectors like consumer staples or utilities, a ratio as high as 75% may be acceptable.
Making investments into undervalued stocks has historically yielded great success, creating some of the world’s wealthiest individuals. Success in this arena, however, demands patience and discipline, coupled with a rational approach to investment decision-making. As articulated by Charles Munger: “A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving diagnosis involving multiple variables.”