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.

Table 13-3
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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