understanding cheap stocks
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Demystifying StocksUnderstanding Cheap Stocks
• To quote the Oracle of Omaha, Warren Buffet: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price!
•The golden rule for any investor is to buy when stock valuations are at a low, so that he can sell them when they rise in value and book good profits.
Introduction
•Valuation is the current worth of an asset or a company.
•Valuation has to be considered in the context of the company’s management, capital structure, past performance, expected future earnings and current market price.
Valuation
Calculating EPS•When considering valuation, it is important to note a few other relative terms such as the P/E Ratio or EPS.
•A price to earnings multiple or the P/E ratio is the share price of the company divided by the expected earnings per share or EPS.
•EPS, in turn is further computed by dividing a company’s net profit by its total number of issued equity shares or paid up capital
•The value of a stock is cheap if it is trading at a low historical price to earnings multiple but has a high or a rising return on equity.
• This means that the company is generating or is capable of generating profits but the current share price is down, given a variety of factors like market conditions, global recession, policy issues etc.
Pricing Cheap Stock
•Analysts usually use the P/E ratio calculated on the basis the one-year forward multiple which is the expected earnings per share in the span of the next financial year.
• Some analysts value stock on the basis of the company’s book value. The book value of a company is – total shareholders’ funds / no. of paid-up equity shares.
• The share price as a multiple of book value gives us a price-book ratio. If the multiple is low and prospects for growth are high then the stock is considered cheap.
• If we add the net long term debt to the shareholders’ funds, it gives us the Enterprise Value which is normally the price which one will have to pay to buy the entire company.
Book Value
•There are some shares that have been trading at discounted prices as compared to their price- book value given domestic and global paralysis and recession.
• Any turnaround or change in current economic conditions would help them rise in value and thus, currently make them lucrative investment options.
Impact of Economy
•As buyers or investors, it pays to remember that cost and worth do not mean the same thing.
• While cost is what you pay, worth is what you get. When considering buying stocks cheap, do not only consider price - Do consider its worth a few months from now.
• If it is worth more, invest in it and strike a bargain. If not, find one that is, buy and hold. Markets are cyclical.
• Every low will be followed by a high and it’s a matter of time.
Conclusion
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