Value investing

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8. Earnings

A focus on earnings is more often associated with growth investing than value investing, but occasionally a company will be trading on such a low share price relative to its earnings that it becomes outstandingly good value.

First of all, you need to understand the key ratios associated with earnings:

1. Earnings Per Share (EPS) = Earnings / Number of Shares in Issue

Example

2. Price/Earnings Ratio (P/E) = Current Share Price / EPS

Example

Having calculated EPS and P/E, you might think that value investing involves plumping for companies with the lowest P/E.

In fact value investors traditionally avoid stocks with very low P/Es because often there is a reason behind the low rating. For instance, a publishing company may be making good profits but trading on a low multiple because the market knows that its most valuable copyrights are due to expire in five years' time.

Ben Graham advised investors only to buy stocks where:

• sales and EPS are rising
• the P/E is below that of competitors in the same industry
• the P/E is below its own past P/E (i.e. earnings rising, P/E declining)
• the P/E is between 7 and 10

Those conditions may be over-stringent, but they do give a guideline to the value investing approach to earnings.

1. What is value investing? 2. Ben Graham 3. Does value investing suit you? 4. Back in fashion 5. Undervalued assets - introduction 6. Undervalued assets - property companies 7. Debt 8. Earnings 9. Earnings - an example 10. Dividends 11. Ratio of market capitalisation to sales 12. Warren Buffett's principles 13. Why do stocks become undervalued/overvalued? 14. Conclusion

• Value Growth Investing