Value Investing (3)
February 28th, 2008 Ogbuotobo Chuks || chuks@stockmarketnigeria.com
By Ogbuotobo Chuks
Watch out for a drop in p/e ratio
The first criterion is to check how far price-earning ratio has declined against the historical average for the company. A company’s stock tends to trade at about the same price-earning ratio over time. If the ratio has declined significantly from this level, what it means is that either the price has dropped significantly or earnings have increased without a corresponding mark up of the price of the security.
If it is a price drop, you can expect it to spring back to the average and if it is a leap in earnings, it will soon begin to register positively on the share price. In either case, when a stock’s p/e ratio is down 10-15 per cent from its historical five-year average, it is a good point of entry. The winning strategy in value investing is to enter a stock which is likely to do better than the market’s expectation before the market begins to see the signal.
Target high dividend yield
The second selection strategy is to consider the dividend capacity of a fallen stock against the market’s average. This is usually applicable to blue chip companies that pay a substantial dividend. As the price of the stock falls, dividend yield improves. The idea is to target a falling blue chip that pays regular dividends until the next likely dividend works out a yield that is significantly higher than those of leading equities. Companies that pay regular dividends are demonstrating their ability to stand in good and in bad operating seasons.
Another good signal to watch when prospecting for value stocks is to establish who have been buying and selling the stock of late. Buying by corporate insiders tends to suggest that they may be seeing a turning around that is not yet visible to the market. Sustained selling by them indicates otherwise. A deep rooted buying interest by key investors must be differentiated from a temporary mopping up of a falling stock to shore up the price.
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