The simple formula to make money is finding value stocks and waiting for the market to realize their values. Only buy when the market is not risky. Most successful investors are doing this.
The book value of a stock is simply the net worth of a company (= Assets – Liabilities). When the stock price is higher than the book value per share (i.e. ‘Stock Price / Book Price’ > 1), it is over-valued. When this ratio is more than 2 or less than 0.5, you have to be cautious and find the reason. Many intangible assets such as the competitive edge have not been priced into the book value. Hence a high ratio may not be an alarm. When it is way underpriced, there may be a critical reason.
Intrinsic Value includes the intangibles such as patents. However, both the Book Value and Intrinsic Value have not been convincing as predictors to me from my tests and experiences. Briefly, describe some basic but important metrics here.
· Expected Earning Yield (E/P). The future appreciation depends on future earnings and the current price of the stock (you do not want to overpay). I prefer a range between 5% and 30%.
· Growth of Earnings and growth of sales. Compare them to their rates in the same quarter last year. I prefer 10% or higher.
· The management is measured by ROE. I prefer 10% or higher.
· How safe it the company? It is measured by ‘Debt/Equity’. I prefer less than .5 (same as 50%). However, some industries are debt intensive.
These are the ratios readily available from many sites including Finviz.com except reversing the expected P/E for expected Earning Yield. There is no need to dig into the complicated financial statements to start. Just ensure the metrics are up-to-date.
For more of my reasoning, check out the book described next. It has 800 pages (6*9) for $9.99. It could be the best $10 you ever spend.
The above is an abstract from my book "Complete the Art of Investing" which is available from Amazon.
I challenged to have the best-performed article in Seeking Alpha history, an investing site, for recommending 5 or more stocks in one year after the publish date. The concepts for that article are discussed in this book.