Picking Stocks at 52 Week Low: What You Should Know September 6, 2018

It has been proven over the years that value-oriented strategies beat the market over a longer time horizon. These strategies include, but are not limited to, selecting stocks based upon low ratios of price to book, price to earnings, price to cash flow and price to sales.

Price to Book

Price to book ratio (P/B) reflects the value that the market attaches to the company’s shares relative to its book value of equity. It is typically above 1. Should the P/B fall below 1, it could mean that the company is undervalued but it could also mean that the company is facing financial distress. In actual fact, to put it more accurately, P/B gives us an idea as to whether you are paying too much for what would be left if the company went bankrupt immediately. It is more suitable to be used for companies with mostly liquid assets such as financial firms as compared to firms with a lot of intangible assets such as information technology companies which are “patent intensive”.

In my opinion, I would prefer firms with a P/B greater than 1 as it tells me that there is market value added. It is unavoidable for strong companies to sell at a premium though it might be said that there will be greater opportunity to find bargains in the small cap arena (market capitalisation of US$1billion to US$3 billion) because they are more lightly analyzed and more likely to be mispriced.

Price to Earnings

Another valuation multiple that I would prefer is price to earnings (P/E). P/E reflects the value investors are willing to pay per dollar of earnings. A high P/E suggests that investors are expecting higher earnings growth in the future as compared to companies with low P/E. However, a low P/E could mean that the stock is undervalued. The definition of what is high and low is relative to the industry. And the company’s P/E has to be compared to its industry’s average.

A simple approach that I would like to take in value investing would be to look at billion dollar cap companies that are able to generate a strong Return on Equity (ROE) for shareholders of above 10% and still be able to have a lower P/E compared to its industry’s peers. ROE reflects the amount the company is able to generate per dollar invested by its common shareholders – the greater the ROE, the more profitable the company is. Thus, a high ROE and a low P/E as compared to its peers would mean that the company is of quality and is likely undervalued at this present moment.

Technical Analysis

We would advise clients who are choosing to pick stocks at the 52 week low to use technical analysis to confirm their entry timing. An effective technical indicator that I use would be the stochastic oscillator. It is a technical momentum indicator that compares a security’s closing price to its price range over a period of time. The crossover of the fast line over the slow line at the 80 and 20 mark serves as a confirmation of an overbought and oversold condition respectively. At the price of a 52 week low, should there be a crossover of the fast line and slow line at the 20 mark, it indicates an oversold condition and you can consider entering.

Conclusion

In conclusion, given the volatility of the current market, we would encourage using a dollar cost averaging strategy when investing. This means that instead of investing a lump sum, you can avoid timing the market by investing the same dollar amount in the same counter over a period of time. For instance, investing an amount of S$1000 every month into a specific counter at the then current price, so you can buy into a greater number of shares when price declines and a lower number of shares when price increases. It eliminates emotion in trading amidst market unpredictability.