There are many opportunities in the stock market for investors and traders but it’s really up to us on how to gauge it depending on the time horizon and risk appetite we set for ourselves. Common questions for new investors are; When is the best time to buy? What is the golden formula for stock-picking? When to know if the stock price is already cheap?
As of this writing, stock market is still on a downtrend as of last week’s close of trading. It closed 7,078.20 from the 9,098.37 all time high in January this year. A 16% drop of the index, making it the worst performing stock market in the world. However, some analysts believe that our stock market is still expensive among Asian markets which are at 15x P/E and they expect that Philippine index may go down further to 6,600 level to catch up that average valuation.
Is it a bad thing? Maybe, maybe not. For me, short-term downtrend are good opportunity for investors to get in and buy. For others, it was just another bad day. This is often overlooked. While most people are waiting for the next uptrend, big financial institutions and wise investors are starting to buy and accumulate shares during price corrections. They are lurking around to look for stocks at a bargain. Once the market recovers, they are the winners! But, how do they do it?
Using fundamental analysis
“Buy stocks as you would groceries, you buy on sale”- Christopher Brown
Have you ever experienced the following scenario: you buy 1 kg of galunggong in Pasig Palengke at 70 pesos/kilo, only to find out they were available at 50 pesos/kilo just a few feet away? Aren’t you disappointed at having to pay more for the same quality of galunggong?
The same applies to stocks.
If you buy a share of company “A” for 70 pesos and later on find out that the share of company “B”, with better earning prospects is available for 50 pesos, it is bound to disappoint you.
So, how do you do bargain-hunting? Does the price justifies the current earnings or projected earning of the company? Does the current price of the stock makes sense?
Price to earnings ratio or what is popularly known as P/E ratio is the answer. It is a formula for valuing a company that measures its current price relative to its earnings per share. It simply means, how much investors are willing to pay for a 1 peso earning of a company.
It is also a good opportunity to spot for an undervalued company which might signal for a good buy or to see an overvalued company that might trigger for investors to sell their shares. It is very important to know that price is the amount you give. Value is what you get.
This is the formula:
P/E= current price÷ earnings per share (4 quarters/12 months)
There are credible tools today to get the financial report and financial data of the company such as investagrams, bloomberg, wsj.com, pse.com.ph, or your own brokerage platform where you can get the earnings per share (EPS) or P/E ratio itself. One of the easiest ways is PSE EDGE.
This is the annual financial report of Philippine National Bank (PNB). As we can see above, it posted a 5.70 earning per share for 2017 and 6.53 earning per share for 2018. If we are going to apply the formula, it will have 8.25x PE for 2018. As a rule of thumb, 20-25 P/E is the average range. It should also be closed to or lower than the P/E ratio of the Philippine index which is around 17x P/E today.
Things to remember:
1. P/E ratio is good when you compare one company to another on its similar sector such as banking,holdings,property,mining,etc.
One way to know when it is overpriced is when the average P/E ratio in that sector climb far above the average.
3. Companies that are losing money do not have P/E ratio or has a negative P/E.
4. A low P/E ratio doesn’t always mean that the stock is already cheap.
It can also mean that people are not yet interested in the stock. Many investors made their fortunes spotting these ignored but fundamentally good stocks before the rest of the market discovered their true worth.
5. A high P/E ratio doesn’t always mean that the stock is already expensive or overpriced.
It can also mean that investors are anticipating for a future significant earnings and they are willing to pay the price.
Using Technical Analysis
“Success occurs when opportunity meets preparation”- Zig Ziglar
If you are using Technical Analysis, where price is always the King, there are also ways to get the best price of the stock that you want to buy. During a sharp decline or when the general market is on a downtrend, it is normal that stock price would go down sharply. Traders and investors find it as an opportunity to spot a “battered stock”.
A stock that has experienced a huge sell-off from large institutions or from the public, but remains giving consistent earnings with good fundamentals is likely to be the next candidate. This is when Relative Strength Index (RSI) comes into play.
WHAT IS RSI?
RSI is an indicator that is widely-used in analyzing financial markets. It is momentum oscillator and it does measure the magnitude price movements. RSI has a scale from 1-100 and many traders like to use these two levels, the 30 and the 70 to spot stocks that are oversold and overbought.
Overbought= is when the stock is above 70 RSI. It means that the stock has experienced very strong buying. Above this area is also subject to profit-taking. However, RSI can stay on this area for an extended amount of time when it is bullish and the demand is high.
Oversold= when the stock is below 30 RSI. It means that the stock has experienced heavy-selling and it is a matter of time that the buying public will go back picking the stock. It is normal for a stock to stay on that range for a period of time on a downtrend.
This implies that when the RSI reaches oversold level and below, it is most likely that price movement will slow down and, possibly, overturn upward. Best time to buy is when RSI is starting to point-up.
The magic words in identifying a cheap stock depends upon you. P/E ratio and Relative Strength Index are best tools to use to improve your success in picking a good and promising stock. P/E ratio can give you an idea if the price of the stock justifies its earnings or its projected earning while RSI is used when you are looking for a good entry to buy a stock that has experienced a huge decline. Both have limitations but using them can help you in many ways.
If you want to learn how to pick good and promising stocks, kindly read my previous article: How to make money in stocks: Follow these 7 simple tips.
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