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What to look for in value investing

Many factors can help investors identify strong companies with stock that is temporarily undervalued.

Check out P/B and P/E ratios

A starting point may be to look at the price-to-book ratio (P/B) and the price-to-earnings ratio (P/E).

The price-to-book ratio is the stock price divided by the book value (the value of the company's assets). If a stock's price is $20 and its book value is $30, the price-to-book ratio is 2/3.

A stock with a price-to-book ratio of 2/3 or less may indicate a value stock. Similarly, the price-to-earnings ratio is the stock price divided by the company's annual earnings.

A stock with a price-to-earnings ratio of 2/3 or less that of other companies in its respective industry or the market as a whole may also be a value stock.

Also, check out ROE

Another important factor to review is the company's return on equity (ROE). The ROE is a percentage calculated by dividing the net income of a period by the common stock equity, or net worth.

Specialist Meric Greenbaum, center, works at his post on the floor of the New York Stock Exchange, Friday, Jan. 10, 2020. Stocks are off to a mixed start on Wall Street after the government reported that U.S. employers eased back on hiring last month. (AP Photo/Richard Drew)
Specialist Meric Greenbaum, center, works at his post on the floor of the New York Stock Exchange. (Photo: AP Photo/Richard Drew)

When it comes to value investing, a declining ROE can be a good thing, since it may suggest that the company is financing with less debt and holding more assets, which could be used for acquisitions or other growth.

Of course, further investigation would be necessary to confirm those reasons.

Don't forget the other fundamentals

Value investors also may examine a company's dividend yield, or the investor's annual percentage of return per share, as well as its debt load, cash flow, assets, and earnings history.

Identifying these figures can help investors evaluate whether the company has the resources and expertise needed to grow profits and deliver earnings in the future.

Dive deeper: Value investing 101: Everything you need to know

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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