Buy Cheap Stock

Many people are always looking for great deals cutting coupons and looking for great value to buy a cheap item, but how many people buy cheap stock? Unfortunately so many novice investors not only wouldn’t know what a cheap stock looked like if they saw it, but those who do aren’t even looking for a cheap stock to buy, because they get too emotional and respond irrationally rather than buy and hold. If you’ve ever been out to a party and you’ve heard about all the different types of people buying stocks and bragging about their returns, perhaps it caught your interest. Unfortunately many people think of “cheap” in terms of dollers, rather than values. To compare lets say person A bought a 24 pack of a certain beverage, while another person bought a single can. Now the person who got a single can of stock thought he got it for cheap because he got it for $1.00, while his friend got the 24 pack for $10. The fact is, the person who got the 24 pack got it for a much better price. In stocks it works the same way. This article will attempt to define what exactly makes a stock worth buying, and teaches you to buy cheap stock on your own.

With all other things being equal, the cheaper stock in terms of dollers per share would be the best stock to buy. Unfortunately, things aren’t that simple. A company may offer a hundred thousand shares or a hundred million shares, in either case, a company may be worth a lot or a little. This is what is so confusing to people. If every single company was required only to offer 100 shares and people bought shares in fractions, then a single share would represent 1% of the company. However, with so many more shares available, it can take anywhere between thousands and hundreds of thousands of shares just to own one percent of the company. Of course, the larger the company and the more it’s worth the more shares it will require. Even if you were able to buy 1% of each company, many people would much rather have the larger company as 1% of a 100billion doller company would be 1 billion dollers. Obviously people aren’t going to pay 1 billion dollers per share, so the company must dilute the shares by issuing more so it’s affordible for most people. Ultimately the stock is cheap if you can get it less than what most people in a normal market would pay for it. Stocks can sell off hard due to margin calls, remain low after improving it’s earnings due to neglect, or sell off due to manipulation, false rumors, or investors being concerned about a perceived risk that may or may not be a real concern. Whatever the reason, a good investor can find the cheap stocks and buy them.

Google may cost something like $500 per share, but that doesn’t make it more expensive than Microsoft. There are many ways to measure value. Perhaps the most common way is by price/earnings. This is known as a P/E ratio and it is easy to identify at yahoo finance, or another similar site. Another way to identify stocks value is by net asset value. This is basically what a share of stock is worth in tangible assets at this current moment. You can identify this by looking at a company’s balance sheet. Another way to identify a cheap stock is by it’s price to earnings growth. Take for example a stock that had a P/E of 3 but was actually shrinking it’s earnings by 10% every year. Next year the stocks’ P/E would be higher as the earnings shrunk. Where a stock with a P/E of 5 with a 100% growth rate would have a P/E ratio of 2.5 next year. The stock with the P/E ratio of 5 would actually be cheaper in terms of where it’s going to be at next year. If you assume the company will grow as expected, this is a cheaper stock to buy. So the price to earnings growth is really what you should be looking at, unless you don’t expect the company to hit it’s numbers.

So how do we buy cheap stock? We need to identify a stock that is cheap based on various factors, and once we have narrowed it down and done our due dillegence we can use our favorite brokerage such as a website like scottrade, and place the buy order there. But first things first, lets identify a stock that fits certain criteria.

Using Zacks, we will go to their research wizard. If you don’t have that, you can simply use their free custom stock screener. What we are going to do is start out finding cheap stocks that are cheap in terms of P/E. So we will screen all stocks that have a P/E ratio of 10 or less. From there, we will also make sure that the PEG is under 2. P/S or price to sales ratio is another important indicator. We want to make sure that each company’s growth and earnings isn’t coming from the liquidation of previous assets, and we want to know that the company is cheap relative to how much it’s actually selling. So we will make sure the companies have a P/S ratio of under 3. For me, cash flow is very important, and I want a company that has the cashflow to pay for it’s own growth and to pay for it’s previous liabilities. I don’t care as much about debt as long as it has the cashflow to cover it. So I want a company that’s cheap realative to it’s cashflow. So we will screen all stocks with a P/Cashflow ratio of 5 or less. Now book value is a way to measure value as well. Book value is what’s left over on the books, it’s the companies assets minus liabilities. If you take a companies price divided by the book value, and you get a number less than one, you have an indication that you can actually buy those assets for less than they’re worth. So if the company bought 100 million in material, and has 20 million in cost, there’s 80 million in material. If buying out all shares of the company would cost 60 million, you’re getting 80 million in material for 60 million. This is one way to get a cheap stock, it’s like buying a doller for 75 cents. You only realize that cash once a stocks’ been appropriately valued, but it’s like using a coupon for your goods. So we will seek all stocks that match their book value or better. P/bookvalue must be one or less. Finally Current Ratio measures the value of a stocks current assets and current liabilities. If A stock has a current ratio of 1 or MORE, that means it has MORE current liabilities then current assets. This means that it doesn’t need to depend on it’s earnings or growth to cover it’s own butt, and it doesn’t have to depend on selling it’s assets to make payments. A company that has more current assets than liabilities is undervalued and thus cheaper than one that doesn’t. Lets summerize the screen and show you the results.

P/E (F1)         LESS THAN      “10″   
PEG Ratio        LESS THAN      “2″   
Price/Sales      LESS THAN      “3″   
Price/Cash Flow  LESS THAN      “5″   
Price/Book       LESS THAN      “1″   
Current Ratio GREATER THAN      “1″   

 RESULTS: 

Company Name	Stock Symbol
BABCOCK&BRN AIR	FLY
GENCO SHPG&TRDG	GNK
LMI AEROSPACE	LMIA
KOHLBERG CAPITL	KCAP
ASHFORD HOSPTLY	AHT
CONNS INC	CONN
EAGLE BULK SHPG	EGLE
AMER ORIENT BIO	AOB
SEASPAN CORP	SSW
PHH CORP	PHH
HERSHA HOSPTLY	HT
DHT MARITIME	DHT
CHINA SEC&SURV	CSR
DUCOMMUN INC DE	DCO
CHIQUITA BR INT	CQB
DANAOS CORP	DAC
AERCAP HLDGS NV	AER
SKILLED HLTHCR	SKH
SUTOR TECH GRP	SUTR
CAPLEASE INC	LSE
BANCO LATINOAME	BLX
MIRANT CORP	MIR
CEDAR SHOPN CTR	CDR
FELCOR LODGING	FCH
BLACKROCK KELSO	BKCC
COVENTRY HLTHCR	CVH
TUTOR PERINI CP	TPC
FIVE STAR QLTY	FVE
ALLIED CAP NEW	ALD

So these 29 stocks will certainly give you a starting point on cheap stocks that you can buy. However, this is titled buy cheap stock, not buy cheap stocks. So that means we need to narrow the list down to a single stock. Now you can pick one of the qualifications that I gave you already, or you can choose one of your own factors. Perhaps a cheap stock is good, but you want one with a history of growth, or perhaps you like a nice dividend, whatever you decide, simply add it on to the screener. I hope you have your own ideas and decide to go with whatever works best for you.

So for this example, I’m just going to pick a few things that I like to see. I like stocks that pay a dividend. Call me paranoid, but after the worldcom’s and other companies with accounting fraud, I like to see a company that will pay a dividend. It doesn’t have to be much of a dividend at all, I just want to know that the company is paying it’s shareholders. So a dividend of .01 or greater is find. I also like to see that a company has a positive return on assets, return on equity, and a return on investments. I believe that which has will have more, and vise versa. So if I’m going to buy a cheap stock, I need to know that the company can show improvements and get something out of it’s assets, it’s investment, and it’s equity in the company.

Now I have 8 stocks remaining. LSE, BLX, BKCC, DCO, EGLE, KCAP, FLY, SSW. In looking at these, I realize that EGLE doesn’t belong because it has a negative growth rate so there’s 7 left. The PEG was under 2, but the growth rate was negative. Now some people won’t be okay with ANY of these stocks because all of them have high debt/capital. However, I am okay with it because they are undervalued, they expect to grow, and I realize that with affordibility you may sacrifice something, and in this case there is a higher risk. So, what now? Well, I like to see what the communities think. So I can enter these stocks in the zacks community, or in the CAPS Fool community. Now LSE has 1 star… it’s gone.  KCAP and FLY have 5 stars so they’re in. BLX and SSW has 4 stars, they’re in. BKCC and DCO and has 3 stars… they can stay, but barely.  Now we have 6 left. So lets head over to Zacks’ community.

Unfortunately KCAP, FLY and BLX don’t have enough people rating it for it to have any stars. SSW is 5 stars so with 5 start AND 4 star i looks excellent. Now BKCC and DOC don’t have ratings either. If you wanted to pick 1 cheap stock to own, you would probably buy SSW at this point. However, I would prefer more in depth research. A quick look at the balance sheet shows that it is under valued, and SSW is certainly one that I would like to own. Based on this screen, SSW is the best stock to buy. I might prefer more research to see if the others also look like better buys, but if you want to buy cheap stock, SSW certainly looks the part.

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