• Relative value trading identifies low-priced stocks that have strong fundamentals. This strategy involves more than simply finding beaten-down, inexpensive stocks. Investors instead attempt to identify high-quality companies that feature strong growth and earnings but appear underpriced.
  
  

Basic Relative Value Stock Metrics

• Investors approach relative value investing by buying a business and not merely a stock. To support this mentality, the company must be in strong financial health.
  
  The first financial health metric is the price-to-earnings (P/E) ratio. The P/E ratio is handy in quickly determining value compared with other stocks. Relative value traders look at companies whose P/E ratios are among the lowest 10 percent of all stocks trading in the markets. Next, value investors consider the price-to earnings-growth (PEG) ratio. This indicates how much potential growth is expected. The PEG on a value stock should be less than one.
  
  Relative value investors look for companies with a debt-to-equity (D/E) ratio of less than one. This indicates the company's financial burden. They also look for companies whose current assets equal at least twice their current liabilities. Finally, value investors like to see earnings growth of at least 7 percent per year over the past 10 years.
  
  

Combining Value Investing and Relative Strength

• The relative value investing model can be enhanced and improved. One of the biggest concerns among value investors is if a company is an undiscovered diamond or heading for bankruptcy.
  
  A value investing study conducted by James O'Shaughnessy in 1998, compared using the P/E ratio along with using the price-to-book (P/B) ratio and the price-to-sales (P/S) ratio. The study indicated that the P/S ratio performed the best of the three, followed by the P/B ratio and the P/E ratio. In addition, he discovered that value stocks exhibiting the highest relative strength outperformed all others. Relative strength was defined as the stock that showed the highest returns over the previous year.
  
  

Relative Value Trading As A Contrarian

• Some successful value traders go against the crowd. It is not uncommon to find them buying when everyone else is selling. This is the contrarian approach to investing. These investors simply wait for companies with strong fundamentals to fall to certain price levels.
  
  Companies whose stocks are beaten down do not necessarily make good investments. Perform due diligence to find out if the company is healthy and why its stock fell.