“Buy Low, Sell High” is the phrase that comes to mind when talking about stock investing.
Easy as it sounds, many investors are still committing the same mistake of buying stocks when they are overpriced. The ability to identify undervalued stocks amidst the sea of market noise is the first step to “Buying Low”.
So then begs the question, how to find undervalued stocks?
We will be providing you with a simple framework to understand the logic behind buying/selling stocks, and two tips to screen for potentially undervalued stocks. Also, we will be sharing what tech stocks we consider to be undervalued stocks right now, even after this broad market rally in 2023.
Read on to find out!
Table Of Contents:
Before we go into the intricacies of analyzing companies and their potential return, we need to first have a baseline understanding of stocks and the overall stock market.
“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes”
– Warren Buffett
This quote from Warren Buffett emphasizes an important mindset for investing – a business owner mindset. When you put your hard-earned money in the stock market, you are not buying random ticker symbols that you see on your brokerage platforms (even though it feels like that most of the time).
Every piece of share that you own is a part-ownership of the company underlying the stock itself, and as shareholders, you are entitled to claim parts of the profits the company is able to generate (assuming that the management decides to return them to shareholders mainly through dividends or share buybacks).
The value of the stock, in its simplest form, is the value of all future expected cash flows the business is going to generate. Furthermore, it must be the present value of all future cash flows as there is an opportunity cost on cash that comes in later.
Intrinsic value is then important as it is a measure of what an asset is worth.
The interesting thing about the stock market is; In the short run, it is a voting machine. In the long run, it is a weighing machine.
To illustrate this with an example.
Meta’s stock price was all over the place in the last 2 years.
Meta was trading at more than $380/share in September of 2021 and experienced a devastating decline to less than $90/share in November of 2022.
That’s a 75% decline from peak to trough in a short span of less than a year.
Thereafter, Meta rallied to more than $300 a piece in today’s market. What is going on?
In this roller coaster ride, Meta has lost more than $750 billion in market capitalization and has since added $500 billion from its lows till today.
Here’s a fun fact: the GDP of Singapore in 2022 was shy of $500 billion ($466 billion to be exact). Meta — just one company — has lost and gained back the GDP of an advanced economy that is ranked 30th in the world.
The point is this – in the short term, markets tend to be highly emotional. The price of a security can fluctuate from $380 to $90 without any real underlying reasons, but neither of these is the true worth of the stock (i.e. the intrinsic value of the company).
Therefore, it is important for us to have an appreciation of the intrinsic value of the companies in our company so that we will not be affected by the crazy movements of the stock market. Ultimately, the philosophy of value investors is to buy BELOW the intrinsic value to ensure that we get a good deal.
An intrinsic value calculation would give you that confidence and benchmark to compare against.
As alluded to previously, the value of a stock is the present value of all future cash flows of the business. Of course, we’ve simplified it a little and skipped a few steps in between.
There are many ways in which investors go about trying to calculate the value of a stock. The commonly cited formulas include:
The bottom line is the same. We are all trying to estimate the future of the business with a few key assumptions.
There are three key pillars that will make up your assumptions.
First, the growth estimates of your projection. Is the company in a sunrise or sunset industry? Does it have a particular competitive advantage that will enable it to grow sustainably? Can it outgrow its competition? Are there any tailwinds or headwinds to prevent, or aid the company’s growth moving forward?
Second, the margins of the business accrue to the bottom line. What is a conservative way to estimate the company’s margin? Are they in a highly competitive industry where it’s a race to the bottom to maintain market share and growth? Or are they able to maintain high margins due to their differentiating factors? Does it have a track record of proving its profitability?
Third, the discount rate which is used to determine the present value of future cash flows. Every company has a different risk profile, a high-growth tech company is going to have a different discounting as a matured, low-growth discretionary brand. The higher the risk, the higher the discount rate should be to account for risk-adjusted returns.
At Piranha Profits, we use our proprietary investing tool – the True Value Finder™, which helps make this valuation process a lot easier. On top of just one method, which is most widely used in the investment world today – The Discounted Cash Flow Model, the True Value Finder will guide you through four other methods to look at stock valuations today.
How to tell if a stock is undervalued using an intrinsic value calculator? Let us show you how it’s done with our trademark True Value Finder™.
**Do note that these figures are calculated as of 06 September 2023 and the intrinsic value of companies may change due to fundamental shifts of the company in the long run.
Based on our calculations, the intrinsic value of MSFT stock is right around $336.88 as of the date of this writing. Comparing it to the last close of $333, it is -1.15% below the IV, which suggests that Microsoft is hovering very close to its fair value. While there is nothing wrong with picking up the stock now, value investors will probably want to wait till the price offers a larger margin of safety (around a 10-20% discount) before entering.
Based on our calculations, the intrinsic value of GOOGL stock is right around $171.83 as of the date of this writing. Comparing it to the last close of $135, it is -21.44% below the IV, which suggests that Alphabet is offering a relatively good level of discount over its IV today.
We believe that Alphabet’s stock currently presents a unique opportunity for potential investors to accumulate at a discounted valuation as market participants are trying to find a consensus on how Alphabet is able to retain its edge in both the search and advertising market with all the new AI talks in town.
If you haven’t noticed, the stock market tends to move in cycles and sector rotation happens more frequently than you would expect. In 2022, the technology sector was hit the hardest due to many recessionary fears coupled with inflationary pressures with no end in sight.
In 2023, you can see that Technology has beaten all other sectors by a large mile. Of course, sectorial rotation is not guaranteed to happen, but it gives us a good basis to hunt for “good deals” that were being punished because there was an overall negative sentiment for that particular industry.
Of course, we need to seek out stocks that are fundamentally strong and would want to be a part of, and not blindly pick stocks in that industry “just because it fell a lot”.
There are many common financial ratios that investors use to look at a company’s valuation such as:
*This list is not exhaustive
This is probably a very convenient way to screen through thousands of stocks, but do understand that many of such metrics are backward-looking in nature. It provides you with a snapshot of the company’s current position and valuation – without much detail of whether the company’s fundamentals have deteriorated.
It would be prudent to marry these ratios alongside key trends like revenue growth, overall margins, and return on equity to have a more complete picture of the business, so as to appreciate both its valuation and business development.
Here’s the bottom line.
On top of finding undervalued stocks, you MUST make sure that it is first a strong and good company. A stock can appear very cheap but can continue becoming cheaper if the underlying fundamentals of the business continue to erode – resulting in it being a value trap.
Of course, not forgetting that even a good stock can be a bad investment if bought at the wrong price!
Want a simple way to identify undervalued deals and avoid losing money to overpriced stocks? Check out our True Value Finder™ and learn to calculate any stock’s intrinsic value with confidence.
Till next time, Keep Winning.
Piranha Profits® is one of the world’s leading online schools for investors and traders. In 2017, we started this online school to make our brand of online lessons and services available to people around the world. Headquartered in Singapore, we have since empowered the financial lives of over 20,000 students across 124 countries. The Piranha Profits® education team is led by award-winning financial mentor Adam Khoo, alongside 7-figure trading mentors Bang Pham Van and Alson Chew.
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