To choose the Right Stock for investing is the real quest in the whole investment process. Sometimes, it becomes frustrating, as we don’t know from where we should start and which method; we should take to find out the best stocks to invest out of the whole lot.
As far as Stock Investing is concerned, no method is ‘fool proof’. However, Value Investing is the best & tested method to invest in the right stock.
First of all, you need to know what Value Investing is.
Value Investing – According to Investopedia, ‘the strategy of selecting the stocks that trade for less than their intrinsic values is called Value Investing.’
However, Value Investing doesn’t mean to pick cheap stocks. But you need to look closely at the depreciated stocks to determine if they are really good stocks or companies on clearance sale. Value is all what matters, not the price.
The framework for value investing was laid out in 1930s by two of the world’s most celebrated financial strategists, Benjamin Graham and David Dodd.
Value Investing is nothing but an investing strategy built on minute and thorough analysis of facts & figures, data and information about a certain stock, which you want to invest in.
Consider Value, not Price
The main point is to differentiate between a value company and a company with a declining price. You have to look for a company which is cheap and high on quality standard.
In Value Investing, the current share price is compared to the intrinsic value and not to historic share prices.
It’s the Business, You are Buying, Not Just the Stock
A stock is a medium by which you become an owner of that company. Being a value investor, for you, profits should be made by investing in quality stocks, and not by trading. In this method, external factors affecting a stock like market volatility or day to day price, fluctuation do not matter. These factors do not have any effect on the value of the business in long term, as they are not inherent to the business.
How to Pick Value Stocks?
To choose the right stock, you have to keep three things in mind:
- The Price per Earning and PEG Ratios
- The Net-Net method
- The Margin of Safety
The Price per Earning and PEG Ratios
Those stocks that are undervalued, shows their undervaluation through a low Price per Earning Ratio. This provides a way to compare the companies in the same industry.
Another metric for evaluating a stock’s intrinsic value is PEG ratio. It is calculated as a stock’s P/E ratio divided by its prospected growth rate of its year-on-year earnings. In simple words, the PEG ratio measures how cheap a stock is while considering its earnings growth. If the PEG ratio of a stock is less than one, it is said to be undervalued.
The Net-Net method
According to Investopedia; the Net-Net method states that if a company is trading at 2/3rd of its current assets, no other measurement of value is needed.
The Margin of Safety
The margin of safety is a very simple but effective technique used to avoid risk. It works when the stock’s intrinsic value is lesser than the estimation made by the investor. It, then, help in preventing the investor from paying more than the real value of stock.
To summarize with:
‘The value investing totally relies upon a strict screening procedure, which results in an opportunity to benefit value investors by buying a stock when the price is deflated.’