Identifying Value Stocks

1. Low PE

• Stocks with PE less than 10

2. Low Price-to-Book ratio

• Discount to book or Net Asset Value (NAV).
• Worth more if broken up and and sold piecemeal.
• Even more attractive if it has (a) Intangible assets (e.g. strong brand), (b) Hidden assets (e.g. real estate, potential spin-offs).
• These are not reflected in financial statements, meaning that the company book value may be understated.

3. Debt-to-Equity ratio less than 1.

• Shows how company structure its capital to finance business.
• Preference for earnings growth to be generated by shareholders' equity rather than borrowings.
• Large proportion of debt incur high interest expenses.
• Could result in more volatile earnings performance.

4. Low Price-to-Cashflow multiple

• Financial health: ability to generate positive cashflow.
• Rule of Thumb: P/CF less than 5.

5. Price-to-Earnings Growth (PEG) less than 1.

• Relates company's future earnings to its estimated growth rate.
• Prospective PE / Estimated future earnings growth rate.

6. High and sustainable Profit Margin.

• Compare gross profit margin with peers.
• Shows competitiveness of products and services.
• Able to consistently improve net profit margin.
• Shows management more efficient at controlling expenses as business grows.

7. Quality of management team.

8. Level of corporate governance and transparency.

Note: The most difficult step in the identification of a value stock is determining if it is trading at a sufficient margin of safety to its intrinsic value. Many value investors use a margin of safety of at least 25%.