How to Take the Guesswork Out of Valuing Stocks
I don’t care what investing legend you idolize and try to emulate – Buffett, Graham, Rogers, Lynch – they all share a common recommendation.
Always buy undervalued stocks and sell them when they’re overvalued. Or more commonly: “Buy low, sell high.” Of course, if you’ve invested for more than a week, you know this is easier said than done.
Undervalued (cheap) and overvalued (expensive) are such subjective measures when it comes to investing. Most times we end up guessing and most times we end up overpaying.
But today, let me show you one amazingly simple way to always buy stocks that are truly cheap…
Why America’s Most Successful Investors Buy “Low-Density” Stocks
All you have to do in order to invest like Warren Buffett, or any of America’s most successful investors – and rack up easy double-digit gains – is to buy what I call “low-density” stocks.
I define density like this: The value the market assigns to the cash that a company has in the bank.
- A high-density ratio: Means the market overvalues the cash.
- A low-density ratio: Means the market undervalues the cash.
The reason I focus on cash is straightforward: It’s the most tangible, liquid asset – and the easiest to value. After all, $1 is worth $1, so it’s easy to tell when you’re overpaying or getting a discount.
Let me use an example to make this concept crystal clear…
- Company XYZ trades for $1 per share and has $1 per share in cash (total cash divided by shares outstanding).
- To calculate the density ratio, we simply divide the price per share by the cash per share. In this case, the result is 1.
Here’s the thing, though: A one-to-one ratio is uncommon.
Most of the time, you’ll have to pay a premium for a company’s cash. Right now, for example, the density ratios for more than 480 companies in the S&P 500 are higher than 1, meaning you’ll pay more for these shares than they’re worth in cash.
But it’s even rarer to find a stock trading at a density ratio below 1.
Density Ratio Below 1 = Cheap Stock & Massive Gains
A density ratio below 1 means a stock could be worth $10 in cash, yet it trades for $7.50. Or it’s worth $1 and trades for 75 cents, etc.
And rest assured, whenever America’s best investors can buy $1 for 75 cents or less, they do. And you should, too. That’s because these discounts, understandably, don’t last for long.
Just take a look at Cynosure, Inc. (Nasdaq: CYNO). It traded at a density of roughly 0.70 for about a month this year. Once investors woke up to the bargain on offer, shares surged 138% higher.
There’s another low-density stock up for grabs at the moment, too…
Buy This “Low-Density” Stock Today
If you want to put my low-density strategy to work today, consider Trident Microsystems, Inc. (Nasdaq: TRID), which makes specialized semiconductors used in flat panel televisions.
- With zero debt, $2.87 per share in cash, and a market price of $1.90, it trades at a density ratio of 0.66.
- In other words, when you buy Trident, you’re buying $1 for 66 cents.
Incidentally, such a steep discount also makes Trident a prime takeover target. And with $2.21 billion in cash, Broadcom Corp. (Nasdaq: BRCM) could easily afford the $125 million market cap Trident.
But, even if Broadcom doesn’t pounce on the opportunity, history dictates that other investors will.
Based on its low-density ratio, Trident needs to rebound 51% to return to a density ratio of 1.
I recommend you capitalize on this truly cheap stock before it’s too late.
Good investing,
Louis Basenese
Source: How to Take the Guesswork Out of Valuing Stocks
Did you enjoy this post? Why not leave a comment below and continue the conversation, or subscribe to my feed and get articles like this delivered automatically to your feed reader.
Comments
No comments yet.
Leave a comment