Simplifies the Meaning of Trading Cheap Stocks

Cheap Stocks – How to catch them low and watch them grow!

To quote 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.” The current market levels do provide an attractive opportunity to identify and buy good value stocks.

The BSE Sensex has gained over 15% in the past 10 months following Foreign Institutional Investor (FII) inflows of $17.7 billion. However, stocks of several companies with ethical managements and good balance sheets are still available at attractive valuations.

What is valuation?

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.

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.

How do I benefit from low value or cheap stocks?

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.

What if the markets were to dip lower?

Our recommendation to investors is to buy now and hold. Current market conditions are more conducive to long term trading than short positions. Do not be alarmed at small dips or be lured with temporary highs. Wait for markets to stabilize before you consider your future course of action.

How do I find reasonably priced shares?

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 (long term debt – cash) 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.

• There are some shares that 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.

• (Don’t know if we should quote a competing broking note in our report). A Deutsche Bank advisory recommends investors to consider companies that ply on domestic consumption. The advisory states – “A rising Demi-Ashton ratio in India has the potential of improving productivity, as does the potential of moving peasants off farms and into towns or cities or even rural services. This makes many Indian companies undervalued.” Inspired by Demi Moore and Ashton Kutcher, this ratio considers demographics between 20 and 40. People in their 40s would have a retirement corpus while those in the 20s are spenders and are not worried about retirement. Deutsche Bank expects India to have more people in 40s than in 20s over ten years to 2025. The bank argues that this could lead to a productivity boom in India and good profits for Indian companies that focus on consumption.

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.

Happy Investing!

Kotak Securities
is one of India’s share broking firm offering demat account, online trading, mutual fund and IPO investing service’s along with a research division specializing in Sectoral Research and Company Specific Equity Research. Express your views on their Facebook Page and Twitter Handle (@KotakSecurities) or you can also visit for more information.