Is Cheap Good!

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Pennywise Pound Foolish

When Baron Rothschild was asked how he had amassed an enormous fortune from the stock market, he replied, “I buy sheep (cheap) and sell deer (dear).” You’ve heard the advice countless times. It’s the ultimate guide to successful stock investing but yet, it is the reverse of what many investors actually do!
Investors often think that the lower the price of shares, the better it is to buy more no. of shares of a low price scrip (ranging below Rs. 10 or say below Rs. 50) instead of buying less no. of shares of high priced stocks. The same logic is often applied to mutual funds – and both are incorrect!
Buy low and sell high- Stocks
To identify a value stock, you should compare its price with its fundamental factors and buy when you believe you are getting value for money.

The most commonly used yardsticks to determine this are price/book value (PBV) and price/earnings per share (PE). If these multiples are low, buy the stock. However, this principle may not always work to your advantage. Often, a stock can appear more reasonable and attractive than its peers because these ratios are low. For instance, a stock may be trading at a single digit PE multiple, while the market trades at over 20 times on a trailing basis, or it could be quoting below its book value. However, this is not always a good reason to invest in the stock. You need to examine various other aspects to determine whether it offers good value.

Firstly, you need to study the PBV and PE over a long period, say, three years. This is because one year’s performance can be accidental or stage-managed. Also, it’s not enough for the price-based parameters to be low. It’s essential that the building blocks which make these ratios are improving. So, the sales, operating profit, EBIDTA margin, net profit and return on net worth should be on the rise. If it has no growth or low-growth prospects, it will quote at a discount to its peers or the market. And rightfully so because it doesn’t deserve a place in the sun!
Remember , a cheap stock today may be ZERO tomorrow! So cheap is a relative word – be cautious of where you put your hard earned money! Some investors justify purchasing low-priced stocks by saying, “You can’t lose much on a low-priced stock.” While that may be technically true on a dollar per share basis, you can lose just as much of your total investment on a stock trading at 1 as you can on a stock trading at 50–in either case you can lose up to 100% of your investment.
Think – Would you invest in a “cheap” typewriter company today – or would you invest a company whose price is Re 1 and there are criminal investigations against it?
We are not saying that all low price stocks are wealth-destroyers, it all depends on the fundamentals of the company. So, do ensure that you check out the fundamentals and valuations while investing in stocks instead of looking at stock prices. The PL Mobile App gives you indepth fundamental information so do check it out.
There are several good stocks also whose price may have dropped for various reasons andhas become “cheap” – some of them have nothing at all to do with the soundness of the investment. It’s often just a matter of supply and demand, and this is often a matter of waves of sentiment, not necessarily practicality. That’s why you might miss an opportunity if you only follow price. The time period immediately after a stock’s price has fallen can be a great time to buy low if you’ve done your research into the company, and particularly if you can identify why the stock’s price is low.
Oh yes – low NAV mutual funds are also sometimes preferred for the same reasons! This is worse – Unlike a stock, where the low value could be due to the company itself, the NAV of a fund could be very low for only two reasons – 1) The scheme started recently and so the NAV is just beginning around its issue price or 2) The fund has invested horribly and is sitting on a huge pile of low value stocks by accident. Both are not good reasons to invest! What you look for in a fund is the fund manager’s track record (which often means the 5 year history of schemes she has managed and therefore the NAV is likely to be high as stocks may be of various denominations) and scheme objective, whether it matches your needs and objectives. It has nothing to do with the NAV!
If you wish to invest in fundamentally strong small and mid cap companies or good mutual funds schemes, which can potentially give you superior returns compared to major indices in the long term and help you create wealth, you can follow or join Prabhudas Lilladher services like InvestActive and PMS. Visit for more details on these.

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