We are all looking for cheap stocks. Because if they are cheap, they will soon rise. So say our logic. But when is a stock cheap? Here are a review of the most common tripwires when speaking generally about cheap stocks.
The best that could be desired as a private investor is to buy a cheap stock. To buy cheap and sell expensive is what we all dream about. But just wanting to buy a cheap stock unfortunately opens for a whole series of errors that may come to cost much money.
Mistake No. 1
We will start with an error, that the absolute beginners of the market is likely to commit. Namely, comparing prices of different shares and therefrom assess the stock, which is cheapest. Most investors are happily aware that you can not do this, but let's for safety's sake make it clear that a share price in isolation, says absolutely nothing about whether it is expensive or cheap.
Whether a stock is expensive or cheap, depends on the company's equity and how the prospects for a increase in the stock is. And this again depends on how the current price is compared to its expected earnings in the coming years. A stock is only cheap if there is a sufficient likelihood that it will be sold at a higher price in a given number of days, weeks or months than it can be purchased for today.
If a share costs 1,000 dollar, or 35 cent are amongst other dependent on how many shares a company has issued. Not by how much the company or the stock is worth. Therefore, the share at 35 cents can well be "more expensive" than the share of 1,000 dollar
In fact, you sometimes see that a company deliberately lowers the price of its shares by increasing the number of issued shares. It may, for example be done by giving each shareholder two shares for every one share, he already has (a stock split). This does not suddenly make the shareholder twice as rich, since prices immediately fall by half. And instead of one share at a price of 100 the owner now has saw two shares at 50.
This example illustrates how a stock is not necessarily cheaper at a price of 50 than at 100. Similarly, one can not compare two shares in various companies and conclude that the stock traded at the lowest price, also the are cheapest.
Mistake No. 2
“Buy now, the stock is cheap!”, is a remark that you often hear after a stock has fallen for some time. Considering a stock as cheap just because it once was more expensive, is a disastrous mistake. It is perhaps the worst of all mistakes in the stock market that, in the worst case could cost the private investor his entire capital.
Just look at the listed companies, which in recent years has gone bankrupt. On their way down they were in principle cheaper and cheaper. That is until the company behind the stock went bankrupt and the stock ended up costing zero dollar! Then it can probably can’t get any cheaper. But those shareholders who thought they bought a cheap stock after a fall of 50, 70 or 90 percent, lost their entire capital.
So let's make it clear that a stock is not cheap, just because it was once worth more than it is today. There is usually a good reason why the stock has fallen in value. So regardless of whether one considers it a good reason or not, the market clearly believe, that it is good enough. And that should be respected.
Mistake No. 3
A share is not cheap, because you think that the company behind the stock has more values - possibly hidden values - than a similar company that is traded at a higher rate.
If the market knows these values, yet not let it affect the price, there's probably a good reason for it. You may not know the reason but have to respect it. The market believes that it is right to keep the price down. And if the market - banks, foundations, investment companies, etc. - do not know the values, what speaks in favor for that, objectively, you possess a knowledge of the hidden values that the professionals do not know?
When a company over several years demonstrates an inability to recoup the capital invested properly, the share is not an attractive investment object. And then the share pricefall. Tis does not make the stock sheap. The price just adjusts to the reality.
Mistake No. 4
A share is not cheap, because the company behind the stock has a product that is unfortunately not getting the attention that you yourself think it deserves. If the market does not recognize a product sufficiently, it matters less, that technicians in an exuberant enthusiasm of their own field of experience, believe that the cold stock market people will soon be just as enthusiastic about the product as they themselves are. As long as there is not some certanty that the new and exciting products also are going to bring money to the company, it is only visions and castles in the air. And that won't pay your bills.
Follow the market
Our advice is that you should ignore all these unsubstantiated allegations that a stock is cheap, and instead follow the market. This means that you have to place your money in the shares already rising. Not in those, that perhaps in the future are going to increase.
If these shares again begins to rise, then there is nothing that prevents you jump on the bandwagon at that time. You in this case missed the first 5-10 percent of an increase of 20 or 50 percent or maybe more, but better that than suddenly to sit with a loss of 30 percent and consider why the cheap stock now unfortunately has become even more cheap.
Do not try to buy a stock at the bottom, but follow the old saying: Let the Trend be your Friend. Buy the stocks that are rising and sell them when they do not rise anymore.
Look at the key figures
This illustrates that the numerical value of a stock price is completely irrelevant. What matters is what lies behind the current rate.
One way to get behind the stock rate is to look at financial ratios and try to find undervalued companies. But this also has some pitfalls to watch out for. One of the key figures that are often used in such an assessment, are called P/B-value, which stands for Price / Book value. This number expresses how much the investor pays for a cent of its book value, also called equity.
If P/B is less than 1, you pay less than one dollar for each dollar of equity. The values can, for example. be buildings, goodwill, receivables from customers, etc. minus its debts. At first sight, one can argue that a stock that costs less than the value that stock represents is cheap. But unfortunately it is not that easy. You can find some sites ranking lists of cheap shares, which have just used the ratio P/B-ratio, and such lists are very dangerous.
A stock with a P/B-ratio might be cheap, but it unfortunately can not be read out of the ratio alone. If it could we would all rush out and buy the cheap stock, whereby the exchange rate quickly would be sent up.
The abrupt termination
Usually, a P/B below 1 indicates that the company has posted machinery and buildings higher than what is realistic, or that the market does not trust the company's ability to make money in the future.
And maybe even lack of confidence that it can possibly survive. This does not mean that all stocks with low P/B ratios per. definition is dangerous.
There may well be good deals hidden beneath the surface. But to separate good and bad, one has to make a thorough analysis. It is not enough simply to note that the stock trades at a price below book value. There may well be a good reason for this. A reason, which at worst end up in bankrupcy.
No comments:
Post a Comment