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.

.

Comments
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months. Our beta is only 1.2 (don't click this link if beating the market isn't important to you).

Lists

The 10 Largest Pharmaceutical Companies In the World

The 10 Most Expensive Android Apps

The 9 Most Expensive Designer Bags in the World

The 7 Most Expensive Real Estate in the World

The 10 Most Expensive eBay Items Ever Sold

The 10 Most Expensive iPhone Apps

The 9 Most Expensive Designer Shoes in the World

The 10 Most Expensive Cigarette Brands

The 10 Most Expensive Law Schools in the US

The 10 Best Wall Street Movies

The 10 Most Expensive Golf Clubs Ever Sold

The 10 Most Expensive Golf Memberships

The 10 Best Disney Characters Ever Created

The 8 Best Foods for Gaining Weight

The 10 Most Expensive Colleges in the World

The 7 Most Memorable Ad Campaigns of All Time

The 7 Most Expensive High Schools in the World

The 10 Electric Vehicles with the Longest Range

The 10 Cities with the Worst Drivers in the World

The 10 Most Expensive Dresses Ever Created

10 Islands to Visit Before You Die

10 Famous Celebrities Who Needed Rehab

The 15 Countries with the Largest Oil Reserves

The 10 Most Overused Excuses in the World

The 5 Best iOS Apps You Can’t Get on Android

5 Companies Damaged By Social Media Blunders

The 10 Most Legendary Blues Songs

The 10 Most Lawless Places in the World

4 Reasons China is a Threat to the US

The 17 Most Sugary Drinks in the World

The 10 Most Ruthless Rulers in History

The 10 Greatest Generals in History

Top 8 Travel Destinations for 2015

The 10 Safest Dog Breeds for Children

The 10 Most Stolen Vehicles in the US

The 7 Most Expensive Celebrity Weddings

The 10 Best LoL Teams in the World

Top 10 Worst Marketing Campaigns Ever Produced

Top 5 Diets that Help You Lose Weight

The 10 Best Ways to Stay Awake

7 Artists That Switched Musical Genres

The 10 Most Expensive Cities to Live in New Jersey

The 10 Best High Schools in New York

The 10 Countries With the Least Gender Inequality

The 6 Biggest Musician-Manager Feuds

The 10 Countries with the Cheapest Gas Prices

The 7 Most Theatrical Bands of All Time

The 8 Worst Band Breakups of All Time

The 10 Most Important South American Leaders

The 7 Most Successful Casting Show Winners

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!