One of many quotes from famed investor Warren Buffett is that the first rule of investing is not to lose money and the second rule is not to forget the first. This quote brings to mind value stocks. What is a value stock? Investopedia defines value stock.

A value stock is a stock that tends to trade at a lower price relative to its fundamentals (i.e. dividends, earnings, sales, etc.) and thus considered undervalued by a value investor. Common characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio.

The point of successful long term investing is to focus on value stocks that have long term stable growth potential but are currently undervalued by the market. These stocks are not as exciting as some growth stocks but they are more likely to allow you to follow Buffets rules of investing and not lose money.

Boring Value Stocks

Value stocks are not cheap. They are cheap compared to their intrinsic stock value. U.S. News writes about so-called boring stocks.

Slow and steady wins the day. “It’s human psychology to want to be part of the next big thing,” says Dave Mazza, State Street Global Advisors’ head of research for SPDR ETFs and SSGA Funds in Boston. “Often times, a more steady investment approach may be more lucrative.”

Take gaming company Zynga (ticker: ZNGA), which soared to a peak of nearly $15 in early 2012 before plummeting to less than $3.

Sure, its games – FarmVille, Words with Friends and others – may be fun to play, but the thrill of the investment quickly became a way to lose money. It’s not a new story, as anyone who remembers the dot-com bust will tell you.

Such companies include McDonald’s Corp. (MCD) and Procter & Gamble Co. (PG) – solid companies that are “dividend aristocrats” stocks traded on the Standard & Poor’s 500 index and have increased dividend payouts for 20 consecutive years.

They suggest AT&T, CAT, CVX, MMM and IBM as examples. An alternative is the US Dividend Aristocrats UCITS exchange-traded fund (SDY) that is comprised of these sorts of solid dividend stocks. Key is not that these companies pay the highest dividends but they have histories over decades of routinely paying and increasing their dividends.

Intrinsic Stock Value

Intrinsic stock value is the value of a company or stock based on fundamental analysis compared to its market value. When the fundamental value of a stock is higher than it market value the stock is a buy and vice versa. What is important here is the accurate assessment of long term growth and returns which are the basis of assessing intrinsic stock value. Our sister site, Profitable Investing Tips explains calculating intrinsic stock value.

Benjamin Graham presented investors with a formula for calculating intrinsic stock value in 1962 and modified it in 1974. The 1974 version considers the following:

Earnings per share, EPS, for the preceding twelve months
A constant of 8.5 representing an expected price to earnings ratio, P/E ratio, for a company that is not growing
An estimate of long term growth, five years = g
A constant of 4.4 which was the average yield of high grade corporate bonds in the early 1960 decade
The current yield of AAA corporate bonds = Y
 Where V = intrinsic value
The formula is as follows:
V = (EPS x (8.5 + 2g) x 4.4)/Y

The way the investors were encouraged to use intrinsic value was to derive what is referred to as a Relative Graham Value, RGV. This is to divide the calculated intrinsic value of the stock by its current price. If the result, the RGV, is less than one the stock is overvalued and a bad investment and if the ratio is above one it is undervalued and may be a good investment.

A measure of how well this approach works is the net wealth of Warren Buffett who was a protégé of Benjamin Graham.