This is How You Make Money from the Stock Market: How to Identify Undervalued Stocks

This is How You Make Money from the Stock Market: How to Identify Undervalued Stocks

Tip 2: Identify a bargain through Net Asset Value and P/E ratio

“Buy low, sell high” and you’re well on your way to riches. However, in a market where price is set by demand and future expectations, how is one to know what is the high and what is the low?

The pro answer would be to determine the fair value of a stock, taking into account possible future earnings, discounting risks, scanning the local and global economic environment etc but that takes too long, and seriously, many of us can’t be bothered.

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State(ment of) Asset

A quick tip is to use figures like net assets – easily obtainable from the financial statements. These figures are also useful as screens to filter out the better stocks you may want to have a better look at.

Net assets is total assets minus total liabilities. If its a mutual fund or something, it'd be net asset value (NAV) which is pretty much the same. It means taking all its assets like cash and sum value of its properties and machineries (or the value of the investments of a fund) and offsetting that by its liabilities, its debts and payables. It’s also called the shareholders’ equity as it’s what the shareholders theoretically have after the company pays off all its debt.

Dividing this number by the number of shares gets you the NAV per share. This is effectively the value of the assets that you’re paying for each share, without taking into account the potential earnings of the company. It’s like buying a farm for the value of the land and equipment but not taking into account the rice in the field. If the share price is RM2.00 and the NAV per share is RM1.00, you’re paying RM2 for RM1 of the farm.

Buying for a Song

“Is it possible to buy RM1 worth of assets for less?”

Yes, you can. Companies like DRB-Hicom (1619) are trading below their NAV. This means that if they were liquidated (selling off all of its assets and paying all of its debts), the shareholders will get a nice profit on the price they paid.

However, hold your buffaloes. While sometimes there doesn’t seem to be any apparent reason for the low price, sometimes these companies are undervalued for good reasons: illiquid market, bad economic sentiment, poor earnings outlook etc. That’s why we’re going to look at another ratio.

Next issue: Future earnings and the P/E ratio, but first, some coverage from the Bersih rally tomorrow.