Extracting Value: Value Investing Resource

PE this and PE that. Are we back in elementary school playing kickball?

Nope, we’re talking about investing and a ratio that is a decent marker for how expensive a stock is based on only a few piece of data. Those data are the price of the stock per share and the annual earnings of the stock per share. When you divide the price by the earnings, you get the PE ratio.

PE = Price per Share / Earnings per Share

So what does the PE ratio tell you? It tells you how many years it would take you to get your money back if the earnings keep up as they are. (Of course that is, if the company were to fully retain earnings, or give them all back to the shareholders.)

Growth stocks usually have high PE ratios between 20 and 30. This accounts for all the growth that you’re buying the stock for. For value stocks, these can range greatly. However, if you look into a value stock and see that the price of the stock based on book value is low, say 1 - 2 times the book value, and the PE ratio is low, say 5 - 10, then you may be onto a stock that could prove a value investment.

The PE ratio needs to be taken into account with many many other ratios but it can be a good indicator of how cheap a stock really is based on the earnings of that stock.

Value Investing isn’t a new concept in the world of investing. I’m guessing people have always been look for value when they buy something. But what I’m talking about, analyzing securities, stocks, ownership in a business, in a way that looks to see if that security is undervalued, is something that two very famous investors started to truly consider back in the early 30’s.

For those of you who don’t know, I’m talking about Benjamin Graham and David Dodd. These two are what some might call the fathers of value investing as we know it today. Their book in 1934 titled, Securities Analysis, is the book that brought the value investing approach to investments into the forefront and sparked careers for people like Warren Buffet. Warren learned directly from Ben Graham.

Benjamin Graham and David Dodd made terms like “intrinsic value” and “margin of safety” fun. These two terms ensure a value investor that he or she will be buying an undervalued security. Their methods, unlike trading, teach investors to buy stocks that for one reason or another are undervalued. They taught that even though a company may be getting pounded by the investment world, it can still be a good buy, just based on the intrinsic value of the company.

Benjamin Graham went on to write another book that provides value investors with one of the best resources on the subject ever written in The Intelligent Investor. A book that gives investors easy to follow rules for finding value in the stock market.

These two investors helped pave the way for value investing and in a market where day trading, options trading, buying and selling on any old blog or news article is the norm, their theories still hold water in any conversation. After the blog storm has settled, everyone will always look to what the actual value of the stock is.