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Why you should use this trusted investment strategy with care to find cheap stocks

by , 10 December 2014

As an investor, one of the worst things you can do is pay too much for a share.

If you pay too much and the market has priced in too high an expectation of the company, you're sure to lose money on your investment.

To avoid this risk, you need to find a strategy to help you uncover very cheap stocks.

One popular strategy for finding cheap stocks can actually leave you investing in a financially unsound business.

Read on to find out more…

Why you need to look for cheap stocks

Infamous value investor, Benjamin Graham, advocated a strategy of buying very cheap stocks.

Benjamin Graham believed that by buying shares with depressed share prices, there was very little market expectation of things getting better.

Yet, if they did improve for the company, he stood a good chance of pocketing a healthy profit.

How to identify cheap stocks

There are a number of strategies that you can use to find cheap stocks.

One popular investment strategy is to compare a company’s share price with its net asset value (or book value) per share.

The aim of the strategy is to buy shares at a big discount to their book value, Phil Oakley in Money Week explains.

So does it work?

A 2002 study conducted by Joseph Piotroski, an accounting professor at Chicago University, showed that this strategy does have its downfalls.

He found that by buying shares with a low price to book value ratio (P/B) produced results that were not as good as they could have been.

Professor Piotroski found that many companies with low P/B values were actually in financial distress. And over time, their business continued to falter.

His study showed that the performance of these financially distressed shares offset the returns from cheap companies in better financial health.

In conclusion, Professor Piotroski revealed that by following this investment strategy of concentrating on low P/B stocks, you reduce the overall returns of your portfolio.

So there you have it. Why you should use this trusted investment strategy with care to find cheap stocks.

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Why you should use this trusted investment strategy with care to find cheap stocks
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