Deciding whether a stock is cheap and worth buying is one of the hardest things about investing because it is so subjective. The difficulty with valuing companies can become even more convoluted when taking into account trading patterns and market movements.
This is why it’s best to invest from a value and fundamental point of view. This doesn’t mean you only have to buy value stocks, you just need to make sure you are getting quality value whether you’re buying a growth stock or an income stock.
There are a few easy ways investors can value a stock that have its differences and be compared with another to get a more holistic view of the stock.
The first way many investors and analysts look to see if a stock is over or undervalued is by comparing it to company peers.
The metrics that are used can vary from sector to sector to fit the operations of that industry better, but the gist of it is that comparing companies in an industry and the stock in question to the industry average is a quick way of determining the relative value of the company.
Of course, it doesn’t tell you much else, so you’ll have to dig deeper to find out why it’s cheaper or more expensive than the peers in its industry.
A second way of determining the value of the stock is to look at the same metrics, but rather than compare it to companies in its industry, you can compare it to itself historically.
By looking historically, you can see what sort of range the specific metrics have been at before when the company was doing well or when it wasn’t and compare it to the valuation today.
This can give you a good idea of how investors are viewing the stock and can help point you in the direction of where to research next.
There are a number of factors that can affect how the market is viewing a stock, such as political or regulatory issues, a poor economic outlook for the sector, or even something as simple as a rising debt load.
By looking at these metrics, you can gauge if there are any red flags with the company that may warn you stay away and avoid a potential value trap.
One example of a stock you may notice is undervalued is Equitable Group (TSX:EQB). Equitable is one of the most undervalued stocks on the TSX, but there is a reason for that.
The reason Equitable is so cheap and investors have been avoiding it is because the industry that it’s in has a lot of uncertainty surrounding it right now.
Its main business is Equitable Bank, which operates a branchless model and is currently the ninth-largest Schedule I bank in Canada.
Equitable predominantly issues mortgages, and it issues them to a larger range of borrowers with lower credit scores than the big banks. This leaves it slightly more exposed to a housing correction and potential increase in mortgage defaults than the big banks would be.
Looking at its comparison to the banks, you will see that Equitable is considerably cheaper, and compared to other higher-risk specialty finance companies, the valuation is more in line.
Similarly, since the run up in housing prices in Canada and the acknowledgement by the market that there’s more inherent risk in the sector, the metrics have stayed pretty flat.
Equitable’s value, though, can’t be ignored; it consistently returns nearly 15% on its equity, it’s price to book has a five-year average of just 1.1 times, and the dividend is continuously being increased.
Investors looking for exposure to the finance sector should consider an investment in Equitable, as it’s one of the cheapest stocks on the market at the moment.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Daniel Da Costa has no position in any of the stocks mentioned.