However, as successful traders will also tell you, there’s not just one way to analyze your stock. You have to analyze the metrics that matter to you, and nowhere is that more true than in value investing.
So, when we’re talking about what to look for in a great value investment, we’re actually talking about finding metrics that matter to you. There’s no ‘right way’, so you’re likely to be looking for something bespoke that you can monitor yourself.
Usually, for value investors, the fundamentals are king. Fundamentals are something preached by some of the world’s most successful investors, such as Warren Buffet, who believes that no investment can be made without knowing a company’s financial operating data.
This may seem basic, but it’s something that many investors forget. Knowing the ins and outs of a company’s numbers can help you learn whether stocks are either over or under-valued. So, what else should you look for in a value investment?
The price-to-earnings ratio is one of the most valuable fundamentals, and it’s also one of the best known. This divides a company’s share price by its earnings per share. This then informs you how much each investor is willing to pay for every dollar of a company’s earnings.
By getting this figure, you’ll be able to compare across different companies. For a value investment, you want a low price-to-earnings ratio. However, you must be careful when comparing companies from separate industries, as they may be higher on average in some industries than others.
You need to know how a company finances its assets. Like with price-to-earnings, debt-equity will show you what proportion of financing a company has received for its debt.
Free Cash Flow
Earnings don’t always equal what cash a company actually brings in. This means that, although a company could be claiming huge profits for its past quarter, there could be very little cash in the company’s bank account.
Free cash flow solves this problem, as it tells you how much cash a company has left after its capital investments. Of course, as you’d expect, you’d like to find a positive cash flow for a value investment.
In positive times, most companies will have a good cash flow. However, if you have positive cash flow in tough times, the company is likely to be a valuable investment.
What About Other Markets?
Although value investing can be applied to stocks, it cannot be applied to forex trading. This is because a currency has no future cash flow. Plus, even if it did, it would be unreliable thanks to volatile geo-political situations.
Currencies can only be measured against other currencies, as a currency is only valuable when backed by a government. A paper note is, in itself, worthless.
Currency also has no inherent historical upward bias, like currency markets have, and also experience different bear and bull phases. So, if you’re looking for a forex trading strategy, it’s best to not rely upon value investment. Instead, consult your broker about relevant forex trading strategies.