There are various ways to value a stock, such as checking its earnings, its dividend or its price to earnings ratio. By using these measurements you may estimate how a stock should be priced.
If you find a stock whose measurements indicate its price should be higher, you may have found a ‘cheap’ stock, then buying it on that premise is the concept of value investing.
If buying cheap stocks is value investing then why isn’t everyone doing it? Well some people believe that some stocks are undervalued for a reason. There could be more fundamental problems with the company that isn’t reflected in traditional analysis.
As an example, patents have expired, products have been withdrawn or there are union problems. These issues can cause a stock to be low and not necessarily undervalued. If these problems exist and you don’t know about them you could buy a stock thinking it is undervalued but in fact you could be waiting a long time before you make a profit.
Items like intellectual property and brand awareness do not have a monetary value but give a company added value. Companies like Nike, Starbucks, Harley Davidson and Dell Computers are worth billions. Most of this is due to sales but a great portion is also attributed to market presence.
As these companies are so well known they are rarely undervalued. But there are times to get them under their value. Normally, bad news sends a stock price down. If, for instance, there is a Nike product that is recalled because they are faulty this story will send the Nike share price down. Such a setback is often temporary so the stock price will equalize but there was a window where undervalue stock was available.
It makes sense that buying cheap stock will make you money but the secret is recognizing when it is really cheap and when to buy it.
For teaching and learning about investing:
Teaching Investing Lessons
All about investing and money management. Learn basic investing and financial concepts, including stocks, the stock market, interest, income statements. Lessons, lesson plans, and worksheets.
Information is for educational and informational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.