If you are going to buy shares, EFTs, index funds or mutual funds the answer is yes. In March 2018, the NSE market capitalization was sitting at 2,817.36, and today it is at 2,108.78. Broadly speaking the market is low. As such, you should buy stocks when they are undervalued.
I spent the initial days of December, pouring through financial statements to find myself good buys. It has been quite a fun and rewarding activity – lucrative too, provided I buy stocks that will increase in price. Of course! My approach to stock selection this time, is focused on value – given the prevailing market circumstances.
Here are my five tips to help you out during this exercise and have you a good chance of making you money in 2019:
Buy Low, Buy Quality
The whole idea of buying when the market is low is the find quality stocks that are undervalued. At this point in time, there are more stocks trading at a lower price relative to their fundamentals than in March this year.
If you choose to purchase individual stocks from your broker, you have to be very selective about it. It is best to buy quality stocks when they are undervalued.
To learn more about how to identify quality stocks read: How to Evaluate The Quality of a Stock for Long-Term Value Investing
Do the Math
To identify an undervalued stock, you’ll need to study the company financial statements. You can also use online financial tools such as Rich Data, Mystocks.co.ke or Financial Times Markets Data to study company fundamentals.
There are so many metrics that you can use to evaluate stocks and here are some of the great ones:
- Price-to-Earnings (P/E) Ratio: Useful for comparing companies within the same business. It is found by dividing the current share price by the annual earnings. A lower P/E means that stock is relatively cheaper, but P/E alone isn’t a good measure to conclusively determine whether to buy a stock or not.
- Price-to-Book (P/B) Ratio: Since our goal is to find undervalued stocks, the P/B ratio is a good measure that is calculated by dividing a stock’s price by its equity per share – where a book value less than one implies that the stock is trading for less than the value of a business’s assets.
- Price-to-Earnings to Growth (PEG) Ratio: Useful for further assessment of companies that may have a high P/E but earnings are growing quickly. It is found by dividing a stocks P/E ratio by its projected growth rate over a certain time period i.e. the next 5 years.
- Return on Equity (ROE): A must use to measure a company’s effectiveness in using invested capital to generate profits for shareholders. It is an expression of annual net income as a percentage of shareholders’ equity.
- Debt-to-Equity Ratio: Basically, you don’t want a company that is too heavy in debt – exception of banks – Kenyan banks can have over 4 times the amount of debt to equity. Can be found by dividing a company’s total debt by its shareholders’ equity.
- Current Ratio: Allows us to determine how easily a company is able to pay off its short-term debt obligations and is found by dividing current assets by its current liabilities.
Most of these metrics are already calculated for you on the websites I mentioned above. However, some of the figures maybe trailing figures up-to 12 months. So, if you want exact up-to-date information, you may want to consider doing your own evaluation.
Understand the ‘Why’
The idea of investing in undervalued stocks is based on the premise that the market has underpriced the stock. Thus, we need to understand ‘why’. Understanding the reason why will help you determine if a stock is mispriced or simply just doing badly.
So here are some of the common reasons why stocks are miss-priced:
- Bad News: Bad news in Kenya can be no dividend declaration, election results, court rulings or simply stocks failing to meet expectations of
certain analyst. It can cause investors to suddenly sell off shares, sending the stock into a plunge. - Industry Fluctuations: Certain industries do not perform well all the time. There are economic cycles and other undercurrents that affect performance. Therefore, certain industries that are out of favour are great places to find bargains.
- Missed Expectations: If a company reports miss certain targets in their quarterly earnings, shares can drop. It can drop more than required as investors express their disappointment.
- Market Corrections: Every now and then the entire market will drop or crash (like now) as it tried to
correct itself. This creates a great time to look for undervalued stocks.
Look Beyond Fundamentals
A great rule of thumb when it comes to investing, is investing in a stock that
- An easy to understand product/service
- A sustainable competitive advantage that will protect it from an economic downturn – for example, Safaricom has M-Pesa.
- A company with whose products/services are likely to last for more than 20 years.
Great companies have been known to have easy to understand products/services, have a wide economic moat and great growth prospects. Since we are seeking value, we need to look beyond what the numbers tell us. This way, we can further determine whether a company is a considerably valuable going concern.
Buy & Hold
This is assuming that you have studied all the company metrics and identified
Take the case of Safaricom. It traded well below its IPO price for a very long time, even as people expected its price to increase dramatically.
Don’t give up and sell before you can realize your investing goal. Over-time the market price of an undervalued stock will catch-up to reflect its actual value and perhaps even surpass it.
Learn to Invest
Learn how to invest, market drops are normal, the key is to remain calm, and do your homework. Don’t wait to start investing – invest today!
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Image Credits: Top by Pixabay, via Pexels.
Other related:
- How to Evaluate The Quality of a Stock for Long-Term Value Investing
- What is a Mutual Fund and How to Invest in them?
- How to Apply Warren Buffett’s Famous Investing Advice
- 8 Habits of Financially Successful People that You Should Follow
- How to Avoid Common Mistakes that Mutual Fund Investors Make
- How to Determine Which Shares to Buy the on the NSE
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