If you could buy a a house worth GH?10,000 for GH?6,000, Why on earth will you pass the opportunity to do so.Although investing in equities entails more than this simple logic, this idea is central to identifying undervalued stocks for a portfolio.the thought of this is exciting. But how do you go about it in real life? The following steps could make it incredibly easier to help us identify mispriced stocks to our advantage.How do stocks become undervalued?One of the central ideas of value investing is that the market veers off from the natural prices of stocks from time to time. There are many potential reasons why a stock can become undervalued, but these are a few of the more common ones:Expectations Short-Falls: If a stock reports quarterly results that fall short of expectations, shares can drop more than the situation calls for.
Buyers and sellers may unfair unfairly interpret this to mean a dwindling in the fortunes of the company. This triggers a demand crisis of some sorts that subsequently results in the lowering of the price. The same concept applies to overvalued stocks.
They “trigger happy” buyers think revenue performance above the expected is an indication for success in the future leading the a hike in the price of that stock above what the market value should actually be.Market Crashes and Corrections: If the entire market drops, it’s a great time to look for undervalued stocks.A stock market crash is a rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, economic crisis or the collapse of a long-term speculative bubble. However, public panic is a major contributor.
Hordes of people removing their money from the banks or scrambling to sell their stocks and other assets all at the same time causes economic turmoil and exacerbates any existing economic instability.Although there’s no threshold, they are usually identified as abrupt double-digit percentage drops in a stock index over the course of a few days. Fortunately, not all stocks react to difficult economic times in the same way — in fact, some even do well when the market drops. If you can find them they can help you play defense in your portfolio.
Bad news: Just like when a stock misses analysts’ expectations, a bad news item can cause a knee-jerk reaction, sending shares plunging more than they should.Cyclical fluctuations: Certain sectors tend to perform better at different stages of the economic cycle. Sectors that are out of favor are good places to look for bargains.So When Agric companies perform less impressively because it’s not yet harvest time.
That is when you should be looking at it.Sometimes the effect of government policy on an industry may negative but also temporary and maybe of a correctional nature to help the whole industry bounce back stronger. The difficulty in implementing this reforms may affect the total performance of these companies but in the end they are expected see more improvement. Stock prices for these companies may be low but anticipation and understanding can help one understand the actual value of that stock.
Only look at businesses you understandBy buying stocks of businesses we do not understand, it we would become mere speculators instead of predictors. And in speculating in stocks, there is the tendency of human behaviour to try to “time the market” and “focusing on the price of the stock instead of the price of the business” and make a profit out of it– they are the tradersThis should go without saying, but too many investors buy shares of companies without really knowing how they make their money or having a grasp on the overall business dynamics of the industry. As a rule when searching for undervalued companies, I highly recommend narrowing your search for undervalued stocks to the types of businesses you understand.When Kodak announced that it on the 10th of January 2018 at the Consumer Electronic Show that it would use crypto Technology to sign images to protect Image copyrights, share prices went up by 120% within hours of the announcement. If you understand the Tech industry well, you’ll know that kodak taken advantage of the cryptocurrency buzz and will be rewarded accordingly for it.If you have a strong understanding of the banking industry, as well as real estate, energy, and consumer goods, stocks in those industries should make up the majority of your portfolio. No matter how attractive another industry is, if it’s far from your expertise or grasp you should tread with caution.
When good things are about happening to that stock there’s almost always a buzz about it.However, when it’s about to take a turn for the worse only those who understand may predict right but the spectators would be found wanting.If you really don’t have a good grasp on the pharmaceutical industry so It should completely be out of your fold. I am not a coward — I’m sure there are a lot of great stocks in pharmaceuticals, and somehow many could be undervalued right now, but it’s out my area of expertise. Until I Come to understand how they work, I dare not venture.Understanding the green light indicators There are tons of ways you can use to evaluate a stock, but the following some of the tried and tested best for evaluating stocksPrice-to-earnings (P/E) ratio: You can get this by dividing the stock’s current share price by its annual returns earnings. This useful for comparing stocks in the same industry and a quick way of separating real earners from the talkers. Simply put it’s the price an investor is paying for GHC1 of a company’s earnings or profit.
A lower Price-to-earnings ratio means a stock is “cheaper,”. This should however never be the only metric used to access a company.There are some significant limitations, partly due to accounting rules and partly due to the terribly inaccurate estimates most investors conjure out of thin air when guessing future growth rates.
This is very important as It forces you to look through the stock market and focus on the underlying economic reality.Price-to-book (P/B) ratio: You can also get this by by dividing a stock’s price by its equity per share. A book value of less than one implies that the stock is trading for less than the value of a business’s assets. Value investors use P/B multiples to find stocks with a margin of safety. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware that this varies by industry.
Loading the player…What is the ‘Price-To-Book Ratio – P/B Ratio’The price-to-book ratio (P/B Ratio) is a ratio used to compare a stock’s market value to its book value.
It is calculated by dividing the current closing price of the stock by the latest quarter’s book value per share.Also known as the “price-equity ratio”.Calculated as:P/B Ratio = Market Price per Share / Book Value per Sharewhere Book Value per Share = (Total Assets – Total Liabilities) / Number of shares outstandingA lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware that this varies by industry.This ratio also gives some idea of whether you’re paying too much for what would be left if the company went bankrupt immediately.Price-to-earnings to growth (PEG): Found by dividing a stock’s P/E ratio by its projected earnings growth rate over a certain time period — typically the next five years.
This can be effective for assessing the valuation of a company with a seemingly high P/E, but whose earnings are growing rapidly.Debt-to-equity ratio: As the name implies, this is calculated by dividing a company’s total debt by its shareholders’ equity.Return on equity (ROE): A company’s annualized net income as a percentage of shareholders’ equity. This is a measure of how efficiently a company is using invested capital to generate profits.Current ratio: A liquidity metric calculated by dividing a company’s current assets by its current liabilities. This tells investors how easily a company can pay its short-term obligations.Once you start evaluating stocks and getting a feel for these metrics, it’s a good idea to develop your own criteria for identifying a stock as undervalued.
For example, when I’m hunting for a good value, I like to see a below-average P/E for the stock’s peer group, a debt-to-equity ratio of 0.5 or less, and ROE of 15% or higher. Note that these aren’t set-in-stone guidelines.
Rather, they are one piece of the puzzle that should be taken into consideration.Sometimes the numbers don’t say it all.These numerical indicators are very helpful and a great way to start with your analysis, but there are other things to look at that can be indicative of an undervalued stock.For example, one of Warren Buffett’s criteria is that a company has a “wide economic moat,” which means a sustainable competitive advantage that should protect it from economic downturns as well as from its competitors.Insider buying and selling is a sort of green light.
Basically, if company insiders, it’s staff or investors who hold large stakes and are buying more shares, it’s a good sign that people on the inside feel there’s a good value ahead. While this isn’t a foolproof indicator, it’s certainly worth looking at.You need patience and discipline. Sometimes the overall market prices goes up and most of the companies you will not seem to be performing.
but and that’s should not be an indicator of doom. The market will work it’s dynamics s if you cannot identify an undervalued stock, there’s no compulsion to find such an investment. Never be in ahurry to make a choice that could potentially be disastrous.