It’s pretty safe to say that most people understand the basic concept of “buy low, sell high” when it comes to stocks. But that’s a lot easier said than done and finding those sleeper stocks is the real challenge.
Finding undervalued stocks on the ASX can leave you sitting pretty before long. A few helpful tips can go a long way toward helping you bolster your stock portfolio while also feeling like a stock market expert.
Be Aware of Gross Profit Margin
It bears saying that there is no such thing as a “sure pick” when it comes to any kind of stock. Things can change on a daily basis and even companies that had billions in market share came crashing and burning to the ground. If you are looking for a good place to start, profit margin is always a valuable thing to know.
Companies that have more gross margin than some of their peers provide more wiggle room for growth. Companies that have lower gross profit margin provides a lot less discretionary spending for consumers to compete for.
Check the Balance Sheet
Finding undervalued stocks is tougher than it looks but you can help yourself out exponentially by checking out the balance sheet. It’s a simple concept but make sure that you aren’t investing in a company whose finances you don’t really understand. And the biggest losses you will see tend to come from companies that don’t have the strongest balance sheet.
When you’re looking for undervalued ASX shares, look for the ones that have cash behind them. Those are the ones that can push through unprofitable periods and give shareholders a better chance of a return later on down the line. Businesses that have cash on hand also have lower capital costs, another important factor.
The Road Can be Bumpy
Sometimes it’s easy to get blinded by the good without considering the bad. Given that the ASX 200 Index is up more than 7% this year, it only illustrates that point further. Especially considering that 7% is enough to have erased losses of just a year ago for Aussie index investors.
Don’t just assume that things will be rosy going forward because different factors drive change all the time. Interest rates could go up more than expected. Spending could go down as well. Even when an economy looks like it’s on solid footing, risks are in place that can bring profits down with it. Be aware of the volatility that comes with investing in general and you will be better prepared to face any potential shifts or losses.
Price-to-Earnings Ratio
Maybe the most important factor for determining a company’s value is by checking out the price-to-earnings ratio (P/E). In layman terms, this ratio shows how much you have to spend to turn a single dollar of profit. Low P/E can certainly indicate a stock that’s undervalued, and the ratio is decided by dividing the price per share by the earnings per share.
Earnings per share is then divided by the overall company profit and then by shares that have been issued. Think about it like this. You purchase shares of a company at $50 per share. That company has 10 million shares currently in circulation while turning a profit of $100 million. The earnings per share would be $10 ($100 million divided by 10 million), with the P/E ratio being 5 ($50/$10). This means that you will have to invest $5 to earn $1 in profit. Do your homework and compare the P/E ratios of the companies that you are eyeing.
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