It is as if all stocks have their own currency. A stock priced at $20.00 could be more expensive than a stock priced at $70.00. Prices are relative. What you need to use to see if a stock is cheap, reasonable or expensive is to compare the stock price relative to some other value.
One of the most popular methods is to compare Price/Earnings per Share (P/E) Ratios. Other ones I use is Price/Graham Price (P/GP) Ratio, Price/Book Value per Share (P/B) Ratio, Price/Cash Flow per Share (P/CF) Ratios, Price/Sales or Revenue (P/S) Ratio and Dividend Yield.
P/E Ratios are relative to different sorts of stocks. Generally speaking a P/E below 10 says that the stock is cheap and one over 30 says it is expensive. However, you can have a very high P/E on a fast growing stock and make lots of money when the stock has momentum.
The P/E Ratio I use in my stock tests is the forward P/E Ratio. That is I am using the EPS estimates to calculate the P/E Ratio. I compare this P/E Ratio to the 5 year low, median and high median P/E Ratios I have in my spreadsheet for a particular stock. I often look at the corresponding 10 year values to see what way P/E Ratios are trending. Sometimes I look at historical values, if I have them.
Sometimes in place of the P/E Ratio, I used Price/Funds from Operations (FFO) Ratio or Price/Adjusted Funds from Operations (AFFO) Ratio. This is especially true for REIT companies. These ratios are like P/E Ratio where I compare 5 or 10 year low, median and high median ratios to a current one based on price and forward FFO or AFFO.
The P/B Ratio is also a common ratio to look at. I look at the 10 year median P/B Ratio. The current one uses the latest Book Value per Share and the current stock price. If the P/B Ratio is 80% of the 10 year median ratio, it shows that the current stock price is cheap. If the current P/B Ratio is around the same as the 10 year median P/B Ratio, then the current stock price is reasonable.
For the P/B Ratio a ratio at 1.50 or below is considered to show that the stock price is on the cheap side. If the P/B Ratio is below 1.00, it implies that the breakup value of the company is higher than the current stock price.
I have previously written about the Graham Price . This calculation is trying to come up with what would be a good price to pay for a stock. It uses both the EPS and Book Value in the calculation. So basically, a P/GP Ratio of 1.00 or below would be ideal. However, some stocks you would like to buy never get to a 1.00 ratio.
What I do is look at the 10 year low, median and high median P/GP Ratios and compare this to the current P/GP Ratio I calculated. Basically, I want a current P/GP Ratio that is at or below the 10 year median P/GP Ratio. A relatively cheap stock would be one where the current P/GP Ratio is at or lower than the 10 year low median P/GP Ratio.
Another common Stock Price Ratio is the Price/Cash Flow per Share Ratio (P/CF Ratio). Here I use a 10 year median P/CF Ratio and compare it to the P/CF Ratio using the current stock price and the forward CFPS which is CFPS estimate for the next year if available. If not I can look at the CFPS of the past 12 months.
At the first of every month I go into check stock prices by dividend yield, so I will not go into details here about this.
On my other blog I wrote on Friday about TransCanada Corp. (TSX-TRP, NYSE-TRP)... learn more Tomorrow, I will write about AltaGas Ltd (TSX-ALA, OTC-ATGFF)... learn more on Wednesday, March 30, 2016 around 5 pm.
Also, on my book blog I have put a review of the book The Golden Age Shtetl by Yohanan Petrovsky-Shtern. learn more...
This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. I do research for my own edification and I am willing to share. I write what I think and I may or may not be correct.
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