Finding undervalued securities with value investing

It’s natural to want to find the best deal. When it comes to investing, the same thinking applies.

For long-term investors, finding undervalued securities can help support steady wealth building over time.  Traditional value opportunities can arise when the market misjudges the true value of an asset. Instead of chasing trends, it’s about investing in solid businesses with the belief that the market will eventually recognize their true value.

This approach can potentially turn temporary market mispricing into long-term financial progress.

What are undervalued securities?

Undervalued securities are typically stocks or assets that trade at a lower price than their intrinsic value.

Market sentiment, which are temporary business challenges or broader economic concerns, may contribute to this mispricing. For example, a solid tech company might see its stock price drop due to a single news cycle, even if its core business remains strong.

 The ability to identify undervalued securities through rigorous proprietary research creates opportunities to invest before the market corrects the pricing discrepancy.

How does value investing works?

Value investing involves identifying companies that have strong fundamentals but are trading at a discount.

The value factor focuses on finding these undervalued securities. This means their stock prices tend to be relatively low compared to their earnings, book value or cash flow. For instance, a well-established bank might trade at a lower price relative to the cash it generates, making it a classic value target.

Even though these stocks might not look exciting at first, they often have a strong business foundation. They could end up performing better than expected over time.

Common ways to measure value include:

• Earnings yield
• Price-to-book value ratio
• Cash-flow metrics

Valuation metrics matter because they help you find companies that may be overlooked by the market. This could help you position your portfolio for a potential rebound.

Value investing vs. growth investing 

Value investing focuses on identifying stocks that appear relatively underpriced relative to their fundamentals, while growth investing targets companies expected to grow at an above-average rate.

Value stocks are often associated with more established companies, some of which may pay dividends and may have temporarily fallen out of favour. Growth stocks are often companies that prioritize reinvesting profits to support future expansion rather than distributing dividends.

Value investing can be attractive for investors seeking steady, long-term stability, while growth investing may appeal more if you’re comfortable with higher volatility.

What are value ETFs and how do they work?

A value exchange-traded fund (ETF) is a type of investment that provides exposure to a backset of stocks that are generally considered underpriced due to market sentiment.

An ETF  is a collection of investments that trades on a stock exchange, similar to a regular stock. Value ETFs specifically group together companies that appear attractively priced relative to their intrinsic value.

Investors often use value ETFs instead of picking individual stocks to have better diversification. Diversification can help reduce the impact of any single holding’s performance on the overall portfolio.

Why should you invest in value ETFs?

Investing in value ETFs offers a way to capitalize on market mispricing, potential earnings surprises and historical long-term outperformance.

• Market mispricing: Investors often underestimate the potential of slower-growing or out-of-favour stocks. Value investing seeks these opportunities before the market catches on.

• Earnings surprises: When undervalued companies report better-than-expected earnings, their stock prices can rise quickly. This can benefit investors who got in early.

• Long-term outperformance: Historically, value stocks have tended to outperform their more expensive counterparts over extended periods. This is especially true during economic recoveries.

When does value investing perform well?

Value investing typically performs best during economic recoveries and periods of rising interest rates.

During these times, investors tend to prefer the immediate cash flow and stability that established value companies offer. On the other hand, growth stocks may be impacted when borrowing costs increase.

Understanding these market cycles can help you balance your portfolio more effectively.

What are the risks?

One risk of value investing is the "value trap," where an undervalued security is undervalued based on certain metrics and its price may not recover as anticipated.

Examples may include companies which face structural flaws, poor management or a declining industry. In these cases, the stock price tend to stay low or continue to drop.

Diversifying your investments through a value ETF can help protect your portfolio from the impact of a single value trap.

What is Fidelity’s approach to value factor investing?

Fidelity’s value factor ETFs aim to track the performance of tailor-made indexes that are actively designed to reflect attractively valued companies.

A factor index is a set of rules used to select stocks based on specific characteristics, like their low price relative to fundamentals. Unlike traditional indexing, which often weights companies purely by their size, factor index construction actively targets these value characteristics.

These funds aim to offer:

• Single-factor exposure to undervalued stocks

• An outcome-oriented strategy that seeks long-term outperformance

• An efficient complement to a well-diversified portfolio

The Fidelity Canada Value Factor Index is designed to capture these opportunities by focusing on companies with low prices.

Key takeaways

Value investing is about finding undervalued securities. These are companies whose current stock prices may not fully reflect their underlying value, with the belief that over time, prices may rise as the market recognizes this value.

For young investors seeking long-term growth and diversification across market cycles, value investing can be a compelling strategy. It’s not about overnight success. It’s about steady progress over time.

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