You’ve had your eye on a stock for absolutely ages and suddenly it takes a dive. Your heart starts pounding, you get the sweats – maybe have the sudden urge to pee. Is this it? Are you going to get an absolute steal on this stock? What will you spend all of the money on? Maybe I’ll write a book?
In short, don’t buy a stock just because it’s low. Buy a stock if it’s so low that it has become undervalued. You also need to consider the reason for the dive isn’t going to impact the price recovery i.e. if the company has gone into administration. If a stock is just low but not undervalued, there is a chance it has lower to fall.
For a novice investor, there will be many questions like ‘how do I know why the stock has fallen?’, ‘how do I find the reason for the price fall?’, ‘how do I know if a stock is undervalued or if it’s just low?’. Don’t worry, I’ve got you all covered in this article.
If you come to the end of the post you’re just not getting it, check out my recommended book list – this is how I learnt it all.
What makes a stock low
So… what makes a stock low? A stock could be low for a number of reasons – the market, the industry, the country, the stock itself – there are so many factors to consider so let’s go through each one.
The Market
When we talk about the market, we’re not talking about the local marché. The market refers to the global stock markets. If the market in general is going down, it tends to pull down the share prices of every stock with it. Remember COVID?
If you’re holding stocks and they unexplainably go down – make sure you check out what is happening in the market as a whole before you jump ship. It may well just bounce back stronger.
The Industry
Picture this – you’re a property development company who is listed on the stock market, you’re doing well and the future is looking bright… until a regulator of the property industry publishes some new regulation you need to comply with… dang it.
As share prices fluctuate based on what people THINK is going to happen rather than what is actually happening at the time of buying/selling – investors who are sceptical about the impacts of what will happen in the future, jump ship. If the size of jump is big enough, it may make a splash in the stock price, pushing it down!
The Country
This point is very similar to the industry but when there is political uncertainty, especially in the run up to an election – stocks seem to get really volatile. This is because investors are pre-empting the new government to impose different laws and taxes which will affect everything.
The Stock Itself
The most obvious one is that the stock may be low because of how people perceive the company and its future potential.
A key reason a stock price might plummet is because it’s announced some really shocking performance figures – if you’re invested in a company that is hemorrhaging cash, you’d want to sell your investments too! This is a sign to run for the hills and never look back.
However, a stock may be low because of some controversial statements the company has made. Although the damage is reputational, it can cause customers to boycott and impact the company financially too. Again, poor performance financially translates to poor performance on the stock market too.
How to tell if a stock is low
Amazing – you’re all clued up on what might cause a stock to drop. But how do you differentiate between a stock that’s only lowered or a stock that is categorically LOW.
Indicator that it’s LOW
You’re now going to want to search the news. Give the company name a Google and click on the ‘news’ tab (you know – where you see ‘Images’, etc.). Then look for any news that was published around the time the stock dropped.
Great – you click ‘news’ and you find that the first headline is ‘[your invested company] goes into administration’… Well, at least you can definitely tell that the price is low (*shrugs*) – however if the company is in administration… don’t buy.
On the flip side, you search Google and find there’s a related news story but it’s something that you feel the company can bounce back from. Maybe it’s a profit warning and you’ve done your research and you’re certain it’s just temporary – this indicates the drop is specific to the share and will potentially bounce back.
Indicator that it’s just ‘lowered’
So you’re on Google and you can’t find anything and there is no real reason why the stock dropped then it’s probably just ‘lowered’.
We covered the main reasons a stock might drop when there is no direct reason related to the individual stock in question. To recap:
- News affecting the global market as a whole;
- News affecting the country as a whole; and
- New law/regulations affecting the sector or industry.
The goal is to be looking at stocks that are LOW, not lowER… generally speaking.
Who should buy low stock
Whether you should buy into a stock you feel is low, depends on your experience. It’s just a rule of thumb and not law but it generally gauges your ability to properly research and analyse stocks.
Avid Investor
This investor will have a few fingers in a few pies and will understand key investing terms such as market capitalisation, dividend yield and key research tools. They will also have a significant amount of money invested so will be well versed with the ups and downs investing inherently comes with.
For Avid Investors, if they have researched a stock and feel that it’s below its value is significantly lower than it should be – buying a low stock is a great idea. They can hold through the turbulence and sell in the longer-term for a healthy gain.
Casual Investor
The casual investor will probably have an investing account (regular or S&S ISA) and will have a little bit of money invested haphazardly. This is due to investing not being particularly prioritised or they are too busy researching to actually do any investing.
My recommendation goes both ways for these investors. If you’re too into researching but you have too much self doubt – I’d say you are probably good to go and invest in shares you deem as low. There is no time like the present and you’ll make no gains if you do all the research but none of the investing.
Although you may pick wrong, these lessons will teach you what you for next time so just make sure you don’t put all your eggs in one basket.
For my casual investors that don’t really pay attention and like to invest based on chat’s they’ve had with their mates – I’d probably say to steer clear of stocks that look low. You’re at risk of not researching the stock properly and may invest in a stock that is on the way down to rock bottom.
Never invested before
If you’ve never invested before and don’t know the first thing about investing, I’d suggest not looking at any individual shares for the time being – this includes low stocks or stocks you feel are going to grow.
At this point, you’ll want to fine tune your investing research and skills before dishing out any money. You can always put investments that catch your eye, onto a watchlist and usually these lists will tell you how much the stock gained/lost since you added it to the watchlist.
My recommendation is to invest in a share tracker – this would be a FTSE All Share or S&P 500 as it automatically diversifies your investment portfolio with zero work or skill needed on your side.
For those of you that are ‘casual investors’ or ‘never invested before’
Difference between low stock and undervalued stock
We’ve now covered the ins and outs of low stocks – what makes them low, how to tell if they’re actually low and who should buy into them. The next step to really drive home whether you should invest in a low looking stock, is to assess whether the shares are undervalued.
The key difference between whether a stock is low and whether it is undervalued is actually in their company accounts. These accounts can be found on Companies House or on the respective stock exchange they are registered with.
So now I’m going to show you exactly how we see if a stock is undervalued.
How to tell if a stock is undervalued
You’re probably wondering what value we’re comparing our share price to in order to determine if it’s over or undervalued. And that’s a great question.
We are actually using the amount that is the result of taking the net assets of a company and dividing it by the number of shares in circulation.
An example would be Royal Mail – here’s a screenshot of their net assets from their company accounts:
Here you can see that the Net Assets equals £4,805,000,000 (£4.805 billion) – this is what the business would be worth if it were completely stripped down into cash and their debts were all paid off. This is the net book value (NBV) of the company.
Now we need to divide the NBV by the total number of shares in circulation at this point in time. To find this number, we just go to the ‘Company Info’ sheet on the investment platform as they’ve done this work for us:
So we have 1 billion shares issued and the total value of the company is £4.805 billion – we therefore know that the share price SHOULD ideally be £4.805 per share.
Now looking at the share price – I can see that the shares are currently selling for 588p (or £5.88). So we’d need it to drop below the £4.805 mark before we’d consider this as undervalued.
Hopefully that makes sense?
Why you should aim for undervalue rather than low
The upside of buying undervalued stock
We now know all about low share prices, how to spot them and who should take the leap into investing into them. We’ve also dipped our toes into the world of value investing and how to identify a share that’s undervalued.
You may now be wondering why you should aim for the undervalued shares versus the low shares. Again – another great question.
As mentioned a little earlier, undervalued shares are shares that have been found to be ‘valued’ lower than their actual company net assets. This means that if you add up the total value of the shares… it’s actually less than the company is physically worth…
Imagine you were looking at cars to buy – you’ve done the research and found that a brand new Ferarri was worth £120,000… (who even has that much money?).
You drive yourself down to the car dealership and the salesman is telling you that Ferarri has had some bad press and as a result people are boycotting the cars – sales have been tough and as a result they’ve slashed the price to £100,000. What do you do?
YOU BUY THE CAR FOR A £20K DISCOUNT… DUH? The value of the actual car hasn’t diminished? It’s just the current demand for the car, right? So you take the car off the salesman’s hands for £100k.
Now you wait for the ups and downs to settle and hold out until the car goes back to it’s normal ‘equilibrium’ price of £120k. That’s a cool £20k profit you’ve just made all because the car was undervalued at a point in time – you knew it would bounce back, it was just a matter of when.
The downside of buying stock deemed as low
Compare the above to just noticing that a stock is low. Buying purely on the basis that ‘it looks low’ or ‘it’s had bad press but will continue to trade so it must rebound in the future’ is a very risky business.
If you haven’t done the research or you’ve just completely mis-understood the research and the price is still above the value of it’s net assets, you’re opening yourself up to the potential that the stock will fall even further.
With the booming popularity of ‘The Intelligent Investor’ (on my recommended books list) and the concept of value investing – even if the business is struggling, buying at an undervalued price, the market will quickly rebalance as everyone spots a value opportunity and buys in.