Monday, 13 June 2011

How to spot a cheap share

I'm not going to beat about the bush. Here it is, in a nutshell:

1. Price earnings ratio of between 12 to 15

The price of the share relative to the annual net income or profit earned by the firm on a per share basis.

2. PEG of less than 10

The Price/Earnings to Growth ratio, namely dividing the above price earnings ratio by the growth rate to come up with a figure that can take into consideration high growth companies as well. According to Peter Lynch, in his book One Up On Wall Street, you really need a PEG of one or under. ulp!

3. Price to book ratio of less than one. The lower it is, the lower the share price compared to the company's tangible assets.

Divide the current share price by the book value per share. If less than one, the market is valuing the company at less than the sum of its assets.
4. Tobin's q - has to be under one.

Developed by James Tobin, it measures the market value (i.e. the price to exchange) versus the replacement value. It divides the market value by the replacement value of the book equity. Or, in more simplistic terms, the stock market value by the corporate net worth.

5. Price to free cash ratio: again, the lower the better.

Market price divided by free cash ratio. The lower the better.

That's it in a nutshell. Now go forth ye and trade.

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