11 months ago • 1 min
A “value stock” is a share that appears to trade for less than its fundamental value. Of course, no one really knows what a stock’s true fundamental value is, but by dividing a measure of how much the company is worth (say, its market cap, price, or enterprise value) by a fundamental metric (say, earnings, book value, or cash flows), we can get a pretty good idea of whether a stock is cheap or expensive.
Now, if we rank stocks on these measures, we can construct portfolios of “cheap” (i.e. value) and “expensive” companies (note: not to be confused with “growth” ones). And if we compare how far apart their valuation measures are – adjusting for things like sector differences – we get an idea of how cheap the “cheap” companies are relative to the “expensive” ones. And if we compare that difference, or “spread”, to its own history (blue line), we can see whether value stocks are cheaper than average (above the zero line) or not. After all, the cheaper they are, the more attractive they are.
That’s what makes this chart – from AQR, one of the world’s biggest hedge funds – so interesting. It shows that despite the strong rally in value stocks in 2022, cheap stocks remain extremely cheap versus expensive stocks. In fact, according to that percentile figure, they’ve only been cheaper 6% of the time. Put more simply, it could still be a good time to buy value stocks, as they’ve still got some extra margin of safety embedded in them.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.
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