Hello everyone, it’s Baku again!
You’ve probably heard someone say something like “You should buy stock XYZ because it’s only P1, which means it’s super cheap!” Heck, maybe you even said that to somebody.
It is true that “cheap” stocks are better investments than expensive stocks because cheap stocks have more room to go up in price. But what is “cheap” is actually not what you think it is.
As the title suggest, sometimes a stock selling over P1,000 is actually cheaper than a stock selling around P1.
Later in this article, you can learn about how to determine which stocks are ACTUALLY cheap and are worth buying with the easy method we present. But, for now, let’s begin by learning about the difference between stock value and stock price.
(The example is of a Philippine stock market, but the lessons here are of course applicable in any stock market. Also, any mentioned stocks are for example purposes only and are not purchase recommendations.)
What Is Stock Value?
Stock price is actually very different from what we call as the stock value (also called the intrinsic value.)
It is difficult to truly describe what a stock value is. If you ask 10 financial analysts, you’ll probably get 10 different answers. That doesn’t really help us, so instead, we will offer a simple definition below that most people can agree on.
Stock value, simply put, is the estimated amount that the stock SHOULD be sold. Considering the assets and earning power of the company, the stock value is the FAIR amount that the stock should be bought/sold in the stock market.
There are sooo many different ways to compute a stock’s value. Some are easier and are preferred by investors. Some require using tools like MS Excel.
The easiest one is just to multiply a stock’s Earnings Per Share (EPS) by 15. This is like saying that the value of the stock is 15 times how much it is earning right now. (As EPS is essentially the latest earning for just one stock of the company.)
We can usually find the EPS info from www.bloomberg.com. I usually just google “stock_name bloomberg quote” and you should see the page below
DITO seems to have an EPS of P0.06 (green border), which puts its value somewhere around P0.9 (0.06 * 15). That stock value amount is only useful if we compare it to the price.
What Is Stock Price?
Stock price, on the other hand, is simply how much the stock is currently selling. If you want to buy this stock, you’ll be paying around the stock price.
Stock prices go up and down for many reasons, but usually it depends on how popular the stock is with the investors.
Using the same image above, it looks like the current stock price for DITO is P3.29
So, Is This Stock Actually Cheap?
From our example above, we should be buying this stock for P0.90 only (the stock value), but the market is currently selling it for (the stock price of) P3.29! That’s definitely expensive.
Imagine if someone is selling you an item for P3.29, even though you know the price should only be P0.90. That price is too much for sure!
And that’s basically how we determine if the stock is cheap or expensive, by comparing the stock value to the stock price.
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What About Comparing Two Or More Stocks As To Which Is Cheaper?
The example above is great for understanding the cheapness or expensiveness of a single stock, but what if we want to compare stocks?
Well, there are many ways to do this as well. But the easiest (and also the most popular) way is definitely using the PE ratios of the stocks being considered.
A PE ratio essentially measures how many times we have to multiply the stocks EPS (or earnings) to get the price. I will leave it to you to google more about the PE ratio and how to compute it if you are interested in that, but for now, what’s more important is knowing how to actually use it.
Besides, we can actually just look at PE ratios already computed for us using Bloomberg as noted in the image below.
Important: The lower the PE ratio, the cheaper the stock.
Also important: remember when we talked about stock values above? Well, PE ratio inherently considers that, which makes PE a really good basis as to whether a stock is cheap or not. Usually, a stock with a PE that is 20 or lower can be considered cheap (and 20+ PE means it is expensive!)
Anyway, to compare which one is cheaper, we have the PE ratios for DITO and GLO below. Which one is cheaper based on PE ratios?
We actually have a different blog on even more ratios that you can learn about here: How To Pick Stocks Like A Pro Analyst.
Yes, GLO’s PE of 12.86 is considerably lower than DITO’s PE of 56.22! This means that our simple analysis yields that GLO is actually cheaper right now.
P1,000 Is Cheaper Than P1
So, we’ve established above that GLO is cheaper than DITO.
Wait, what’s this? GLO’s stock price is over P2,000 and is acutally cheap… while DITO’s price at P3.29 is expensive?!
And that’s how a thousand-peso stock is cheaper than single-peso-digit stock!
Price Is Only Half The Requirement To Buy A Stock
This article teaches you the proper way to look at stock prices, and also how to distinguish the cheap stock from the expensive ones. And you will want to buy the cheaper stock because it has more room to increase in price.
HOWEVER, there is another thing you have to look at to determine if it will be a good investment. That is, you have to determine if the business is actually performing well!
A business that is “performing well” is able to profit because the products and services are actually being purchased/availed by the public. They are usually well known with recognizable products or brands.
In short, these 2 things NEED to be present before you buy an investment:
- The business is doing well
- The price is cheap
In the case of DITO and GLO, just because GLO is cheaper does not mean that it is automatically a good investment. We still have to ask if GLO is actually doing well.
Alright, We Have To Clarify Some Things…
- I mentioned getting a stock value by multiplying the EPS by 15. You can actually use another number, usually around 10 to 20. Use higher numbers if you are risk averse, and use lower numbers when you are okay with more risk.
- The valuation method we used is called the PE Multiple Valuation. We’ll probably talk more about it in the future, so make sure to follow our blog!
- Besides the PE multiple, other valuation methods you can try would be the Gordon Growth model and the Discounted Cash Flows Model. However, this could be too much for new and intermediate investors, and your broker probably have valuations already computed anyway! So go ask them if they do, instead of computing these yourselves.
- Sites like Bloomberg sometimes don’t update immediately with their PE ratios and EPS data, and sometimes it’s just an estimate they made. So, make sure to double check with other websites!
- Also, I almost forgot to add this important bit, but expert investors like Warren Buffett and his teacher, Benjamin Graham, actually suggest you buy only if the price is significantly lower than the stock value. Like, you should only buy if the stock price is 80% that of the stock value.
It turns out you can’t actually judge the cheapness/expensiveness of a stock just by simply looking at just the price!
Always compare the stock value to the stock price, and only declare it cheap if the stock value is actually lower than the stock price. Or you can look at the stock’s PE ratio as well.
For beginner and intermediate investors, looking at the PE ratio of the stock is a good way to gauge how cheap it is, especially if you have to compare it to another stock!
Good luck and we hope you learned something!
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