Mastering Value Investing

Value investing is the best type of investing for beginners looking to independently invest in the stock market. It involves buying companies based on how good they are at making money as a business. No hype, no riding the wave—just disciplined valuation of each potential buying opportunity. If you want a deeper overview of value investing (and other types of investing), you can read about it in a prior article here. However, this article aims to pinpoint the metrics successful value investors—like Warren Buffett—use to build their wealth. Let’s dive in!

Before reading, it may be beneficial to revisit the basics of these terms here.

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Price-to-Earnings Ratio (P/E)

The P/E ratio is absolutely vital to understanding a company’s valuation, though it doesn’t tell the whole story. I personally look at both the trailing P/E (based on prior earnings) and the forward P/E (based on projected earnings). Unfortunately, there is no specific target P/E you should aim for, no matter what other newsletters may claim. For example, Nvidia’s P/E is 59.11 at the time of writing, which is very high compared to most stocks and not generally considered fairly valued. However, this matches their PEG of 1.00 perfectly—meaning, on paper, they are perfectly valued despite the seemingly misleading P/E ratio. The same can be true in the opposite direction: a stock can seem undervalued based on its P/E, but the company may be expected to stagnate. So, a low current P/E means little if the company isn’t striving to make advances in valuation.

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Price-to-Earnings Growth Ratio (PEG)

This problem is precisely what the PEG ratio addresses. PEG incorporates the growth of the company into the equation by dividing the P/E ratio by the company’s earnings growth rate. In other words, PEG integrates growth expectations and paints a bigger picture of valuation than P/E alone (though both are necessary and complementary). As mentioned, a PEG of 1—in theory—suggests fair value. Given the current market environment, this often implies undervaluation. Unlike P/E, PEG isn’t as situational, and the usual guidelines are:

• PEG > 3: Overvalued

• PEG ≈ 1: Fairly valued

• PEG < 1: Undervalued

There are limitations to PEG, of course. Its accuracy depends entirely on reliable growth forecasts. Moreover, when growth rates are unusual—either extremely high or unstable—the PEG ratio can be distorted and fail to convey the full picture. Therefore, it’s best paired with P/E to balance the strengths of both metrics.

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Intrinsic Value – In a Perfect World...

You may have noticed that these statistics are reliable in most scenarios but not all, and they have conditions that companies can potentially manipulate. Here’s the good news: there is a solution that works across the board, but it requires doing the number crunching yourself. Stay tuned for next week’s article, where we will learn how to calculate intrinsic value in plain English! For now, subscribe below (it’s free).

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*This article is for informational and educational purposes only. It should not be considered financial, investment, or trading advice, nor a recommendation to buy or sell any securities or financial instruments. Past performance is not indicative of future results. Markets are volatile and unpredictable; no indicator is foolproof.