Selecting a Value Portfolio
The first step is to select a universe of stocks that you are interested
in. This can be done using the Internet to print up the financial
information on stocks of interest. You then can narrow the list
down to stocks that conform with your criteria of value, namely,
the specific price-to-book and P/E ratios and dividend yields. You
can find stock screening tools at various online Web sites such as
www.yahoo.com and www.cnbc.com that you can use to plug in
criteria for screening different stocks to come up with a screen of
value stocks (see Table 13–3). These are not recommendations for
particular stocks because over time the financial fundamentals for
these stocks will change.
Reasons for Selecting these Stocks
Using a stock screen on Barrons’ Web site, the list of stocks in
Table 13–3 was produced with the following criteria: a dividend
yield of greater than 3 percent, return on equity greater than 10 percent,
and 3-year EPS growth rates in excess of 10 percent. The list
was reduced based on PEG ratios of less than 1, with the exception
of Microchip Technology. From this list, the fundamental value for
each of the stocks was considered. BP and Chevron were chosen
because they are among the largest global companies in their sectors.
Future growth in the supply of basic materials and oil would
not keep up with the growth in demand from the emerging
economies of China, India, Brazil, and Russia. Dow Chemical, an
underloved stock, was trading at a lower P/E ratio than its peers
in its industry. If valued like its peers, Dow Chemical’s stock price
would trade in the low $60s. Bank of South Carolina had sales and
income growth that exceeded its peers in the regional banking
industry. In addition, its debt-to-equity ratio was less than those
of banks in its industry. Unilever N.V. is a global consumer goods
pick. The parent company of the Unilever Group is a leading
supplier of food, home, and personal care products around the
world. Knightsbridge Tankers Limited is a small-cap international
stock whose primary business is the transport of crude oil. If the
Knightsbridge stock was valued like its peers, it would trade in
the low $40s.
Value Stocks Based on Fundamental Factors
Low PEG ratio stocks were selected because this measure is an
indication of potential value. PEG ratios of less than 1 indicate that
the stock might be undervalued because of prevailing expectations
that the stock’s earnings growth might not be realized. APEG ratio
of greater than 1 indicates that the stock might be overvalued
because the earnings growth rate is less than the P/E ratio.
The initial screen of stocks was reduced based on debtto-
equity ratios. With the exception of Unilever, all the stocks in
Table 13–3 have low debt-to-equity ratios.
Over long periods, earnings drive the growth in stock prices.
Look for companies that will be able to sustain increased earnings
over long periods of time. Companies with three-year growth rates
that were in excess of their P/E ratios were chosen.
The dividend yield is another measure of value. All the stocks
selected had dividend yields in excess of 3 percent. Stocks with
high dividend yields are attractive to value investors, who can
collect the dividends while waiting for capital appreciation.
Value investors select stocks that they believe are undervalued
relative to their fundamental intrinsic value. These are
some of the measures used to determine value stocks.
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