Goldman Sachs Group Inc (GS), Apple Inc. (AAPL), Verizon Communications Inc. (VZ): Is That ‘Cheap’ Stock Worth It? Use This Tool To Find Out

Fundamental analysts generally focus on a company’s financial statement. They use tools like the price-to-earnings (P/E) ratio and dividend yields to find value. Many investors like to buy when these indicators are low.

There are studies showing that this approach works in the long term. However, most of those studies could never be implemented by individual investors.

When studying P/E ratios or other fundamental measures of value, researchers generally divide the market into 10 groups. Each stock is assigned to one of those groups. Researchers then measure the performance of the group and usually find that the group with the lowest P/E ratio or the lowest dividend yield provides the best returns.

Apple Inc. (NASDAQ:AAPL)

There are at least 6,500 stocks being traded on U.S. exchanges. To duplicate a value strategy that is likely to outperform the market, you might need to buy 650 stocks. You could just select the stocks with the lowest ratios in the S&P 500 and perhaps buy only 100 stocks. As you can see, the problem an individual investor faces is that their account isn’t large enough to buy so many stocks.

To help narrow the list, individual investors can apply a tool of technical analysis to fundamental data that will help them identify the stocks that deliver the best value.

Bollinger bands are used in technical analysis to spot when prices are too high or too low. This indicator adds and subtracts two standard deviations from a moving average of the price. It can easily be added to any chart using many popular websites.

Bands are designed to include about 95% of the price action, so when prices move above or below the bands, it is unusual and a signal that something significant is happening in the market. When prices break above the upper band, they often reverse lower or at least consolidate the recent gains. Prices crossing the lower band often signal a low-risk buying point.

Bollinger bands can actually be applied to any indicator, including P/E ratios and dividend yields. When P/E ratios are very high and above the upper band, the stock price is overvalued and could be ready to fall. Stocks with P/E ratios below the lower band could be the best value stocks in the market.

For example, Goldman Sachs Group Inc (NYSE:GS) has a P/E ratio below 12, a level generally associated with an undervalued stock. However, the P/E ratio is actually at the upper Bollinger band and is high relative to its normal value. Rather than being undervalued, Goldman Sachs Group Inc (NYSE:GS) is more likely to be overvalued when the P/E ratio is placed in context.

Apple Inc. (NASDAQ:AAPL) is also relatively overvalued despite an unusually low P/E ratio around 10.

On the other hand, Verizon Communications Inc. (NYSE:VZ), with a P/E ratio of about 130, could be a buy with a P/E ratio near the lower Bollinger band.

Value investing is appealing to many individual investors because it seems logical. The idea is to buy stocks with low P/E ratios and avoid those with high P/E ratios. Unfortunately, the absolute level of a P/E ratio tells us very little about whether an individual stock is a value stock or not. Adding Bollinger bands to the P/E ratio could help investors find unusually cheap stocks and could help them to avoid stocks that are overvalued on a relative basis.

Action to Take –> When selecting value stocks, consider the P/E ratio within context and decide whether it is high or low based on the history of the P/E ratio for the stock you are looking at.

This article originally appeared at ProfitableTrading.com
The Indicator That Could Keep You From Getting Fooled by ‘Cheap’ Stocks

Warren Buffett’s Top 5 Stocks Buffett’s firm, Berkshire Hathaway, holds dozens of stocks. But these five make up 75% of its portfolio… worth $65 billion. Click here to get Buffett’s top 5 stocks plus his 16 latest buys, FREE.

.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

50 Crazy Facts About Japan You Won’t Believe

Top 10 Least Expensive Hybrid Cars to Save the Planet With

The 10 Biggest ‘Gate’ Controversies in History

The 10 States with the Highest Nursing Shortages Leaving Their Hospitals Depleted

The 10 Best Value Investment Blogs that Every Investor Must Read

The 6 Cheapest Boarding Schools in Europe 2015

The 5 Most Expensive Cars To Insure in the World

The 10 Most Common Genetically Modified Foods

10 Self-Made Billionaires Who Came From Nothing

The 10 Most Expensive Cities to Live in North America

The 13 Most Expensive Headphones in the World to Represent

The Top 20 Wealthiest Soccer Teams in 2014

4 BuzzWorthy Cannabis Stocks And Some Smoking Derivative Plays

The 10 Healthiest Fast Food Chains in America to Dine At

The 5 Most Expensive Cat Food Brands You Can Spoil Your Kitty With

The 6 Best eCommerce Platforms for Small Businesses

The 10 Worst Mistakes an Entrepreneur Can Make

The 5 Most OP Characters in League of Legends to Carry Games and Crush Foes With

The 5 Best Foods to Eat Before Running that Will Help You Pound the Pavement

10 Glaring Plot Holes in The Walking Dead that a Zombie-Filled Bus Could Drive Through

The 5 Biggest Celebrity Stoners Who Love Their Reefer

The 10 Most Overrated Movies Of All Time by Out-of-Touch Critics

Top 6 Least Expensive Cruise Destinations For 2015 that Will Take You to Paradise

10 States with Lowest Substance Abuse Rates in America

The 14 Most Watched TV Finales Ever

The 10 Best Selling Role Playing Games of All Time for PC

10 Most Influential Papers In Economics

Top 8 Biggest Charities in the US

10 Worst Celebrity Career Moves Ever

Top 10 Best Paid Tennis Stars in the World

10 Cities with High Demand for Nurses

6 of the Worst Greeting Card Messages Ever Crafted

How to Make Money in ArcheAge and Build Your Empire

10 Foods To Eat To Lower Cholesterol Levels

The 10 Most Hated Television Characters of All Time

The 30 Worst Halloween Costume Ideas Ever Brought to Horrible Life

10 Vocational Skills in Demand Today with Jobs Waiting to be Filled

10 Best Places to Visit in Central and South America

The 10 Greatest Empires in History Which Nearly Conquered the World

The 6 Cheapest Boarding Schools In America 2015

5 Clear Reasons LoL is Better than DotA, Continues to Rule MOBAs

The Only 9 Teams with a Chance to Win the Super Bowl

The 15 Most Common Phobias in America that Induce Fits of Panic

Top 6 Least Expensive Tourist Destinations in 2014

Jim Goetz, Peter Fenton, Jim Breyer: Top 6 Venture Investors for 2014

Top 15 Billionaires in 2014

5 Pitfalls To Avoid When Buying a Franchise

Top 20 Medical Schools in the US – 2014 Rankings

4 Business Strategies that Turned Jamie Oliver into the World’s Richest Chef

6 Qualities That Make You A Good Team Player

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!