WHAT IS VALUE?
The foundational lessons of Graham and Dodd provide a recipe for market participants to look at stocks based on a valuation framework and to understand the relative cheapness of stocks. This framework has been used throughout the years, and many have adapted or adjusted it to meet their investment styles or views.
At the most basic level, the goal of investing in value stocks is to buy stocks that are trading at a discount relative to their peers (based on company financials) but have upside potential. How someone measures the relative “cheapness” and determines how much of a portfolio to put in a “cheap” stock are key items to consider when looking at value.
Using company financial metrics, the S&P Enhanced Value Indices seek to measure stocks with attractive valuations based on three key fundamentals.
- Price-to-Earnings Ratio: Calculated as a company’s trailing 12-month earnings per share divided by its share price. A key metric used for company valuation, we use this ratio to identify companies with earnings that may not be reflected in their share price when compared with other companies.
- Price-to-Book Value Ratio: Calculated as a company’s latest book value per share divided by its share price. This metric is key in understanding what proportion of a company’s assets are priced into the shares of a company.
- Price-to-Sales Ratio: Calculated as a company’s trailing 12-month sales per share divided by its share price. This metric is used to identify companies that might not have consistent earnings but still maintain robust sales growth relative to their share price appreciation. These three ratios were selected to identify the stocks that could have the most potential upside value relative to their share price. For each stock in the underlying index and for each metric, a risk-adjusted z-score is calculated and a simple average of these three z-scores is taken.
These three ratios were selected to identify the stocks thatcould have the most potential upside value relative to their share price. For each stock in the underlying index and for each metric, a risk-adjusted z-score is calculated and a simple average ofthese three z-scores is taken.
