Hey guys. This is Zig-Zach Gamer back with another joke of the day.
And the Joke is...
How does a Skeleton call his friends?
On the Tele-Bone.
This is Zig-Zach Gamer signing out. Bye!
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How do you determine whether a stock is undervalued or overvalued?
Today we'll talk about
the simplest way.
Today, the topic is about
the simplest way to know whether a stock is undervalued.
There are actually many ways .
Let's start with the simplest way.
I would like to use analogies.
Let's introduce this guy to you call "Ashton",
So imagine that Ashton has a house
which is worth $1.5 million.
and he also have cash worth $500,000 in the bank.
This will form his assets.
at the same time, he didn't fully pay for his house
using all his cash.
He took some Bank Loan
and there's outstanding amount of another $500,000.
So that forms the liability for Ashton,
in this case.
Usually people ask
what's the 'networth' right?
So 'Networth' essentially is
having the assets minus the liability
that will give you, in Ashton's case, $1.5 million
because 1.5 + 0.5 = 2 million
and - 0.5 million of mortgage
that's $1.5 Million networth.
And imagine that
Ashton is for sale, hypothetically...
in the market and he's priced
at $1 million.
So you can actually buy him
and own his assets
and of course his liabilities.
Everything as a package for $1 million.
In that case, if you know that
he is worth $1.5 million,
and you only paying $1 million.
So we can simply say that
Ashton is actually priced in an undervalued kind of way.
So, stocks can also be seen as
using assets and liability to assess
the networth of a stock.
We DONT use net worth to
to determine whether a stock is undervalued,
We call it "Book value".
It's actually the accounting method to determine
whether
how much the company is worth.
So, it's known as Book value.
So what's essentially the simplest way,
is to determine whether
the price is below the book value of the company.
The share price whether it is below the book value of the company.
So if let's say you use this ratio
called the "PB ratio" or" price to book value" ratio,
if let's say this ratio is less than 1,
essentially it's saying that the price is LESS than the book value
okay?
and this is a most simplest way to determine
whether a stock is undervalued or not.
And of course,
stocks that passes this criteria,
tend to have problems
that's aligned with them.
Why would a stock be undervalued,
If it's good stock,
it's unlikely be undervalued right?
It should not be selling below its networth.
Especially growth stocks,
which investors expect that
the company's worth more in the future, than what it is currently now.
So, investors are willing to pay
more than what this current worth is.
Which means good stocks tend not to be
below price to book ratio.
So, likely stocks that passes this kind of criteria,
tend to have problems.
They may be in unsexy businesses,
or they may even be in sunset industry
and they may even incur certain losses over the years,
and they may be smaller companies,
or even bad management.
So there are tons of problems
that associated with this kind of undervalued stocks.
And generally investors tend to shun them
because they don't like the problems associated with
these companies.
But that said right.
researchers have done a study
that if you buy very cheap stocks,
which are very low price to book stocks,
your returns are actually higher,
regardless of all the problems that persist in these companies.
So for example,
one study that they have done
was that bottom 10% price to book ratio,
that means the cheapest 10%
versus the top 10% by price to book ratio,
that means your most expensive stocks by
price to book ratio.
So when they compared the returns over several years,
they found that,
on the average,
if you have bought the cheapest stocks
by the lowest price to book ratio,
you'll gain 1.6% returns per month
as compared to
if you have bought the most expensive,
you only give 0.6% per month.
So it's almost 3 X more returns.
If you have bought
the cheapest stocks by the price-to-book ratio itself.
So I hope through today's session,
you have learnt how to determine,
the simplest way to determine whether a stock is undervalued,
and historically, based on research,
it's also proven that such stocks deliver high returns.
So as a matter of fact,
do not be concerned about some of the problems
that you may face, when looking at these companies.
Some of them may not be permanent issues
like losses can be temporal.
so which means there are opportunities for you
to find this undervalued stocks,
and gain much higher returns over the long run.
So I hope today is a good lesson for you guys
and that you can use it for your own investment.
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