Wednesday, October 17, 2007 0 comments ++[ CLICK TO COMMENT ]++

Looking for Undervalued Stocks

Paul Price wrote an article titled The BIG MISTAKE Business schools teach their students to make every day that I found insightful.

I don't really know if his argument that one should be looking for variables that change with the price is as unique as it seems. The reason people, especially value investors, look at static variable is because they want to pick a value for the firm while comparing the stock price to that.

In any case, what I find useful is his emphasis on looking at valuation measures such as P/E and P/BV relative to the normalized values for that company. A lot of people, including me, tend to look at valuations relative to competitors and we don't pay enough attention relative to the company's own valuations in the past. I guess this is a newbie mistake and something I should avoid making. I made this mistake once before* but I need to keep it at the front my head.

(* The mistake you can make by looking at valuations relative to competitors is that the market may not equalize the valuations for numerous reasons. The mistake I made was with an oil&gas supermajor called Petrobras (PBR) a few years ago. I looked at it and bought it because it was trading at a low P/E relative to other supermajors. I don't remember exactly but I think its P/E was something like 6 or 7, whereas most others were in the 9s and 10s. I made money simply because there was a huge bull market in oil but the reasoning was all wrong. PBR's P/E never really expanded as I thought it would due to a whole hoard of issues (such as country risk, government control, price controls on some downstream products in Brazil, etc). Right now I think the whole energy sector is in a speculative mania but if it weren't for that, I probably wouldn't have made any money on PBR. For what it's worth I sold out very early so I didn't make as much money as those holding it in the last few years.)

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