5 tips to identify bargain stocks
Several days ago, i wrote about screening for stock using the following criteria:
- Price/Book ratio < 1.0
- Return on equity > 10%
- EPS growth for next 5 years > 10%
- Debt to capital ratio < 25%
- Market cap > 2 billion
Someone asked my how do I come up with these…
Price/Book ratio: this compares the stock price and the book value per share. If this ratio is below 1, the stock worth more than the price. We all want to get bargains, right?
Return on equity:This measure how effective and profitable the company is. If ROE is > 10%, for every dollar the company is worth, it generates at least 10 cents.
EPS growth: Some companies stock price drops because they don’t have bright future. When we search for stocks to buy, we better bet on companies with consistent growth.
Debt to capital ratio: Borrowing is a way for company to get the capital to grow. However, excessive borrowing could be problematic. High debt may be ok during good times, however, it could destroy a company during bad times. One recent example is American Home Mortgage. It was the biggest mortgage lender. However, when subprime mortgage crisis surfaces, they didn’t get the necessary financing and it has very large debt to capital ratio. It ultimately declared bankruptcy and caused severe loss for shareholders.
Market cap: I personally prefer established companies because they usually have longer history and more analyst covering. In addition, there are more buyers and sellers and their shares are more liquid.
These 5 tips gives us some stocks that have low price, effective management, good growth and are less likely be wiped out during down market. Of course, picking a winning stock requires much more these. One needs to take a closer look at their balance sheet and business to understand if it is really a ‘value stock’ or a ‘value trap’.
