Winning investment strategy: How to find stocks trading at a discount

by , 01 July 2015

By using a straightforward way to value stocks, you can uncover the companies trading at a discount to the market or their competitors.

This way of stock valuation concentrates on cash.

Let's take a closer look…

One way to value stocks

What a company does with its cash is more important than just having cash alone. This is because cash is non-productive.

So when companies have a lot of cash, it’s useful to remove cash from valuations of stocks. By doing this, you can see how much you’re spending on productive assets. In other words, those that make money, Tom Dyson and William Wikula in Palm Beach explain.

Let’s take a look at how this works with help of an example…

Removing cash from a stock’s value

You’re looking at investing in cash rich Company ABC. The company’s shares are trading at R28.49 each. Its price earnings (PE) ratio is 16.5 and its earnings per share (EPS) is R1.72.

The overall market is trading on a PE of 19.4.

First of all, you need to find out how much the company has in cash in its most recent balance sheet. Then divide this by how many shares there are in issue. This gives you R10.70 in cash per share.

That makes up 38% of the company’s share price.

To work out the stock valuation minus cash, subtract the cash per share from the company’s current share price. In other words, R17.79 (R28.49 – R10.70).

This method of stock valuation can reveal huge discounts

You can use this to work out Company ABC’s cash adjusted price earnings (PE) ratio…

Cash adjusted PE ratio = R17.79/R1.72 = 10.3

This is against Company ABC’s ‘normal’ PE ratio of 16.5. This means Company ABC is trading at a 47% discount to the overall market by concentrating on the company’s productive assets.

This stock evaluation tool shows that Company ABC is trading at a very attractive value.

So there you have it. How to find stocks trading at a discount.

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