Investing in ASX value shares

Investing in ASX value shares

If you’re someone who loves hunting down a bargain, then ASX value shares might be worth exploring.

In this article, we look at how to identify value stocks and why they might be an excellent addition to your investment portfolio.

ASX 200 mining shares value buy An orange sign with the word value against a blue cityscape, representing ASX value shares
Image source: Getty Images

What are ASX value shares?

Value stocks are companies perceived to be trading at bargain prices. Perhaps they have been unfairly punished by the market because of some recent negative publicity, or maybe they operate in a less popular sector of the economy.

Whatever the reason, value shares possess more robust fundamentals than their current share prices indicate.

Why invest in ASX value stocks? 

Value investors seek to capitalise on these discounted stocks by first identifying value shares in the market now, typically by looking at some key financial metrics. They then buy these shares, hoping that their prices will eventually increase to a level more in line with their actual underlying business performance.

How do you identify value shares?

Value investors essentially believe in the principle that the market tends to overreact to good or bad news.

They think investors often get overexcited by a piece of good news about a company and bid up its share price to excessively high levels. But they equally believe that if shareholders see a negative story in the media about a company they own, they tend to panic unnecessarily and sell their shares before taking the time to consider if it is the best long-term decision to make.

This herd behaviour can result in shares falling to bargain prices, allowing other investors to profit by picking them up for less than they’re worth.

Value investors try to identify shares that have been oversold by focusing on a few key valuation metrics. These often include:

Price-to-earnings (P/E) ratio 

This is a commonly-used financial metric that shows how much an investor has to pay per dollar of return on their investment. The P/E ratio is calculated by dividing a company’s share price by its earnings per share (EPS).

A company’s earnings (or net profits) represent shareholder returns. It is the excess cash a company can use to either pay dividends (which means income to shareholders) or reinvest into growing the company (which should eventually translate into a higher share price and a future capital gain for shareholders).

A high P/E ratio shows that investors are willing to pay a lot per dollar of incremental return. While this might be a sign that a company is overvalued, it could also indicate that investors are willing to pay a premium now with the expectation that the company will grow earnings significantly in the future. A low P/E ratio, on the other hand, may indicate that a company is trading at a bargain.

The average P/E ratio for the Australian market tends to be around 15, although this can change over time depending on business conditions and the economic outlook. So a share with a P/E ratio below 15 may be considered relatively undervalued, while a share with a ratio above 15 may be considered relatively overvalued or expensive.  

However, it’s important to point out that, on its own, a share’s P/E ratio doesn’t tell you too much about whether the stock offers good value. 

P/E ratios can be a good measure of relative value when compared against other shares in the same or similar sectors of the market. A share with a P/E ratio that seems low may actually be high relative to its competitors – meaning that the share may not offer good value after all.

Price-to-book ratio (P/B)

A stock’s P/B ratio is calculated by dividing its price by the company’s book value per share. Book value, or net value, is a company’s assets less its liabilities and measures how much a company is worth.

A share’s P/B ratio shows how much investors are willing to pay for a dollar of the company’s net assets. A P/B ratio of around one indicates a share is fairly priced – investors pay a dollar per dollar of net assets. A ratio of less than 0.5 might indicate a bargain to value investors, as it shows that the company’s shares are trading for less than half of their book value.

Debt-to-equity ratio

When a company wants to finance its operations, it can either take out some form of loan (by borrowing money or selling bonds) or raise money by issuing new shares (also called equity). A company’s debt-to-equity ratio measures how much of its financing it raises through debt relative to equity.

A debt-to-equity ratio below one is typically considered safe. If a company finds itself in dire straits, it could sell some of its assets to cover its debts and possibly still survive.

On the other hand, a debt-to-equity ratio of two or above is getting into more risky territory. If the company suffered some sort of crisis, it might find it much more difficult to meet its debt obligations.

A high debt-to-equity can be risky for shareholders because it may indicate that a company has an unsustainably high level of debt. This can pose a problem because a company needs to earn enough money to meet its interest obligations. Otherwise, it runs the risk of defaulting on its loan repayments and could even go bankrupt.

However, on its own, a high debt-to-equity ratio isn’t necessarily a bad thing, and it needs to be understood in the context of the broader industry in which the company operates. For example, some sectors – like the airline industry – generally tend to be highly leveraged, so their debt-to-equity ratios are likely to be relatively high.

Difference between ASX growth and value shares

Although investors buy both growth and value shares in the hope that they will profit from a future gain in prices, they are motivated by very different factors.

Growth shares are typically junior companies that may not yet be turning a profit. Investors buy them based on their perception of the companies’ market opportunities and future earnings potential. As such, growth shares tend to be riskier investments than value shares, although the potential return for investors may be much greater.

Value shares are more likely to be established companies that have been oversold by the market and are now trading at lower prices than their underlying fundamentals would suggest. Investors buy these shares hoping that their prices will soon revert to a level more in line with actual value. 

These shares are typically lower risk than growth shares because they are more likely to be mature companies – but this also means that the potential shareholder returns on offer are probably lower.

5 top value share performers in FY22

(based on market capitalisation from high to low)

Identifying value shares can be subjective. After all, what seems like a bargain to one investor may seem like a bona fide dud to another. Here are some major ASX shares that could offer good value to investors right now.

Company Market capitalisation Description
Woolworths Group Ltd
(ASX: WOW)
$46.28 billion Australia’s largest supermarket chain
QBE Insurance Group Ltd
(ASX: QBE)
$10.09 billion

Leading general insurance company

Qantas Airways Limited
(ASX: QAN)
$10.29 billion Australia’s flagship carrier and largest airline
Treasury Wine Estates Ltd
(ASX: TWE)
$8.05 billion

One of the largest winemaking companies
in the world

Challenger Ltd (ASX: CGF)

$4.72 billion

Financial services and annuities business

Empty heading

Woolworths

Woolworths operates Australia’s largest chain of supermarket and grocery stores. For the half-year ended 2 January 2022, Woolworths generated almost $31.9 billion in revenue and $795 million in net profit. These are some hefty numbers, even if pandemic-related costs mean lower profits than in the prior corresponding period.

However, as the nation shrugs off most of its COVID-19 restrictions, many of those costs may reduce. And while supply-side disruptions remain a risk, supermarkets remain good defensive shares to hold during an economic downturn, as demand for food and pantry staples is relatively inelastic.

Key metrics (as of 30 April 2022):

  • Price-to-earnings ratio: 44.82
  • Price-to-book ratio: 8.58
  • Debt-to-equity ratio (most recent quarter): 289.37

QBE Insurance

QBE Insurance is one of the largest general insurers in the country, selling car, home, and business insurance. It reported a statutory net profit after tax (NPAT) of $750 million for the year ended 31 December 2021 – a massive turnaround after reporting a loss of more than $1.5 billion the year before. And yet its share price continues to languish well below pre-pandemic levels.

Plus, insurance companies tend to do well when interest rates rise. Insurers typically make money by investing the premiums they receive from their customers into fixed-income assets. They can make a greater return on these investments when rates are higher because the interest payments they receive on new fixed-rate instruments will increase. 

Key metrics (as of 30 April 2022):

  • Price-to-earnings ratio: 16.90
  • Price-to-book ratio: 1.44
  • Debt-to-equity ratio (most recent quarter): 40.78

Qantas Airways

One to buy for the post-pandemic economic recovery is Qantas, Australia’s flagship carrier and the largest airline in Australia. It is also the third-oldest airline still in operation in the world after KLM Royal Dutch Airlines and Colombian airline Avianca.

Qantas shares were sold off heavily during the COVID-19 pandemic, as border restrictions and lockdowns seriously limited people’s ability (and desire) to travel. But now, as borders reopen and domestic and international travel tentatively resumes, Qantas could be due for a comeback.

Key metrics (as of 30 April 2022):

  • Price-to-earnings ratio: N/A
  • Price-to-book ratio: 886.44
  • Debt-to-equity ratio (most recent quarter): 1,214

Treasury Wine Estates

Shares in Treasury Wine Estates collapsed in 2020 after the Chinese government announced that it was hitting its Australian wine imports with a whopping 169% tariff – and the industry hasn’t fully recovered since. Treasury Wine Estates used to sell about $500 million worth of wine to China each year, and the tariffs dealt a devastating blow to the company when COVID-19 lockdowns were also limiting wine sales to hospitality venues.

However, excluding mainland China, revenues for the six months ended 31 December 2021 increased almost 50%, and the company is now exploring expansion opportunities elsewhere in Asia. It is also growing its presence in the United States, targeting the premium end of the wine market.   

Key metrics (as of 30 April 2022):

  • Price-to-earnings ratio: 33.48
  • Price-to-book ratio: 2.18
  • Debt-to-equity ratio (most recent quarter): 51.17

Challenger

Challenger is an investment management company that specialises in annuities. When you buy an annuity, you pay a large sum of money upfront in exchange for a regular stream of income over the investment term. In the case of a lifetime annuity, the term is the rest of your life. These products cater mainly to retirees who would like to ensure they have a source of steady income throughout their retirement.

Like QBE, Challenger stands to benefit as interest rates rise because it invests its capital into fixed-income investments. It then uses the interest from these investments to make regular payments to customers. As rates rise, the return Challenger earns on new investments increases, and so should its profit margins.

Key metrics (as of 30 April 2022):

  • Price-to-earnings ratio: 10.35
  • Price-to-book ratio: 1.19
  • Debt-to-equity ratio (most recent quarter): 141.33

Are ASX value shares right for you?

Value investing requires a fair amount of research and industry knowledge. It’s not always easy to identify which ASX shares are bargains and which are genuine duds – which often makes value investing a subjective exercise. You’re not always going to get it right. What you think might be a temporary drop in a company’s share price could be the beginning of a significant crash.

Therefore, before deciding to invest in a company, always make sure you have a firm grasp of its financials and understand the key factors affecting its industry. And, most importantly, make sure you can explain why you think the market currently undervalues it. If you can’t do that, then it’s just pure speculation!

Last updated May 2022. Motley Fool contributor Rhys Brock has positions in Treasury Wine Estates Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Challenger Limited and Treasury Wine Estates Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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