Our Los Angeles based financial advisors specialize in wealth management and retirement planning and have received client inquiries about value investing–the process where an investor selects companies whose stocks are currently undervalued by the market. This type of investing has regained considerable popularity following the bursting of the growth-oriented technology bubble.

If a company with a solid history of good financials is being overlooked by the market, or if it is being beaten down by the market for temporary reasons (e.g. a new product launch is receiving tepid consumer reaction, a new movie is bombing at the box office, the CEO is undergoing heart surgery), a value investor regards this as a buying opportunity with the expectation that their prices will eventually rise to their true worth when the market adjusts or after the company’s temporary issues or problems are remedied. It is critical to understand the following about value investing:

• Be patient. This can take weeks or years, but it is at that time when you have the potential of a capital gain.
• Be willing to research your investment candidates and their industries thoroughly.
• Be willing to stand your ground when the pundits and the stock market in general say otherwise.
• Be able to let a stock go when you find that its fundamentals have changed significantly.

Most value portfolio managers screen first for fundamental measurements such as price-to-earnings (P/E) and price-to-book (P/B) that are lower than the S&P 500, and then analyze each company’s financial statements. The key is not to invest in cheap stocks necessarily, but in those whose companies are currently undervalued by market over-reaction, misperception, and short-term focus, and whose stocks have catalysts for potential, long-term capital appreciation. This only comes from companies on a sound financial footing with a good track record.

From this short list of undervalued, financially sound companies, conduct a thorough qualitative evaluation by reviewing annual reports, SEC filings, press releases, and web sites. Talk to suppliers, customers, and competitors with the goal of truly understanding the companies—their management in particular—and the industries in which they operate.

It is preferable to invest in companies whose management has demonstrated long-term competency and integrity, and whose top executives have been in place a long time. Researching what suppliers, customers, and competitors have to say about a company can be particularly revealing. If a company is on solid ground with their suppliers and customer base, this can be an advantage against their competitors.

In contrast, if a company is constantly having difficulty with key suppliers or distribution channels, this could spell trouble going forward. Similarly, if customers are constantly complaining, or worse, defecting to the competition, this would not bode well. Interviews with the competition can be a sign of their shifting competitive landscape in terms of changes in market share, target market, pricing power, and geographic penetration.

Bottom Line: Value investing is very methodical, requiring equal doses of quantitative rigor and qualitative insight, and a great deal of patience. It’s challenging to identify these companies and can take 3-5 years or longer before the market “bids up” a value stock to its true worth. However, value investing can be well worth the effort and the rewards can be great to those who commit the time and refuse to pay retail.

Our Los Angeles based investment advisory team has been assisting clients with financial planning and wealth management for more than a decade. Please call us at (800) 632-2463 if you have any questions!