How to Invest in Cheap Stocks
When the stock market is soaring upward, it can often inflate stock prices, making them expensive for smaller investors. Fortunately, there is another way to invest than buying high-priced stocks--learning how and when to buy cheap stocks that are undervalued. By following a few simple steps you can find undervalued stocks with lots of upside potential.
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Instructions
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The Search for Value
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Locate low-priced stocks to find bargains. Go to a computer, log on, and go to a free financial site such as MSN's Investing section. Go to the stock screener and you find that there are two sections: Company Basics and Key Financial Indicators. Leave the settings in place for the Company Basics section and select the following for Key Financial Indicators:
Dividend Yield = As High As Possible
Price/Earnings Ratio = As Low As Possible
Average Daily Volume over Last 2 weeks = Any
Net Profit Margin = As High As Possible
12-Month Relative Strength = As High As Possible
Debt/Equity Ratio = As Low As Possible
Revenue Growth Year vs Year = As High As PossibleThen click the "search" button at the bottom of the page and copy the results into a Word or Notepad document.
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Select from strength. Eliminate any stocks that have a 12 month RS, or relative strength, value that is less than 50. Relative strength is a comparative indicator that measures a stock's performance compared to the rest of the market. Staying with stocks that have a RS of 50 or more filters out underperforming stocks in the market.
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Only invest is cheap stocks that are listed on stock exchanges. Discard any stock that is OTC, or over the counter, issue. You only want to buy stocks from an exchange like the New York Stock Exchange or Nasdaq because of liquidity. A stock with good liquidity will have enough buyers and sellers to allow a quick entry and exit. OTC stocks lack that attribute.
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Determine the market cap for each stock. Go down the list of stocks and note the market capitalization for each. The market capitalization, or market cap, is the total number of shares the company has outstanding multiplied by the value of one share. If you input the stock symbol in MSN's ticker look-up on the site's Investing section, it will pull up the stock price and also tell you the market cap.
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Subtract liabilities from assets to get the net asset value of the stock's company. Check the asset value for the stock in the Research section of MSN's Stock section located in the left-hand column. Input the stock's symbol and it will give you the gross assets and liabilities of the company. Subtract the liabilities from the assets and you have the net asset value of the company. Mark that down by the respective stock.
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Study a stock carefully to judge its value. Determine if the stock's net asset value is greater than its market cap. If it is, then you have a cheap stock with high value and a strong candidate for investment. If the market cap is higher than the net asset value, then discard it as a potential investment candidate.
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Tips & Warnings
Narrow your investment choices by determining if the company has a competitive advantage. If it is a leader in its field and/or is introducing cutting-edge products and services in the marketplace, then it may offer you a better return than other cheap stocks.
Just because a stock is cheap doesn't mean it's a good investment. Sometimes a stock is cheap because it lost its competitive edge in the marketplace, so always study a stock carefully before investing any money. One rule of thumb is to spend as much time studying a potential investment as it took to earn the money you're going to use to invest to begin with.
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