When buying cheap stocks, it's important to know that the definition of a cheap stock lies in the eyes of the buyer. Find out how to invest in a company whose value is lower than it should be with help from a portfolio manager in this free video on investments and the stock market.
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Are you a stock investor and wondering what it means when somebody says that stock is cheap? This is Roger Groh at Groh Asset Management. Well to some people that means that the share price is low but probably to a more sophisticated investor it means that that total company's value is low relative to what it "should be". What determines cheap is in the eye of the buyer because there is no one definition. If it were me, we think cheap is when public companies are priced the same as private companies. An example, you can go and you can buy a McDonald's restaurant, the whole thing in whatever town that you live in. You're going to pay one times the gross earnings in that business and maybe eight to ten times cash flow for a healthy company. Now if you think about it when you do that you have to run it, you have to staff it, you have to deal with all of the things that come with running a large operation. On the other hand you could also go and buy the common stock in McDonald's and you don't have to do anything other than sit back and wait for the dividends to come in. So it's easier and therefore the premium that it sells for is higher than the private buy in the restaurant. How big? Well in today's world it is about double so in my mind when McDonald's is cheap is when the public stock sells at the same price as the private restaurant. It doesn't happen very often but when it does go to Mac's. I'm Roger Groh at Groh Asset Management and thank you very much for spending time with me.