77% Of These Penny Stocks Are Undervalued!

Some of the smartest hedge fund guys I know are always looking for the biggest bang for their buck.  That often means looking for deeply discounted and undervalued companies.  But, finding undervalued companies is often easier said than done.

So that brings up an interesting question…  “How do you tell if a stock is undervalued?”

It’s a great question… and a lot of investors are looking for the answer.  It’s the holy grail of investing.  If you find a solid stock trading at a deep discount, you’re certain to have a winner on your hand.

A big winner.

Now, before I share with you one way to find undervalued stocks, let’s dig a little deeper.  Why would a penny stock get so undervalued?  How does a penny stock price get so out of whack?

There are hundreds of reasons a stock may sell at a discount.  The company could have missed numbers or given lower guidance.  Sometimes a stock can be discounted simply because the market doesn’t understand a company’s true potential.  We’ve even seen great companies sell at discounts because the overall market is struggling.

You might also see a stock deeply discounted because industry news is bad.  That could present a lot of opportunity.

Take for example Chinese stocks trading here in the US.

Their stock prices have been obliterated by the market.  Why?  Because there’s fear about investing in all Chinese stocks.  Investors are concerned about the financial numbers, the potential for fraud, or even a slow-down in the Chinese economy.

Because of these fears, a lot of good little Chinese penny stocks have been thrown out.

But within this fear lies opportunity.

A huge number of Chinese companies are dramatically undervalued by the markets.  Some of these valuations are simply ridiculous.

Of course, I did a little research…

Using my favorite stock screening tool, I looked for traditional Chinese penny stocks.    I screened for companies with less than a $2.0 billion market cap a sub $10 share price.

Then I sorted them simply by one simple valuation metric… book value.

So what is book value and why should you use it?

Book value is comparing a company’s assets with their liabilities.  Let me give you an example.  Let’s say you have a company with $25 million in assets and $5 million in debt.  They have a book value of $20 million.

Now let’s take it one step further…

If the stock trades for $4 and they have 10 million shares outstanding, the market cap of the company is $40 million.  The $40 million market cap divided by the $20 million book value gives us a price to book ratio of 2.0x.

Now, if that same company was only worth $10 million… and still had a book value of $20 million, the price to book ratio would be 0.5x.

Typically, a price to book ratio below 1.0x implies the company is dramatically undervalued.

Now let’s take a look at our universe of Chinese companies.  Of the 170 companies that came up in our screen, 131 of them had a price/book ratio below 1.0x!

Think about what this implies.

It means more than 77% of Chinese penny stocks are valued at less than their assets!  It clearly indicates these companies are dirt cheap.

Now, are they all a good deal?  No, of course not.  You have to be very choosey when selecting companies to invest in.  But one way to find deeply discounted stocks is to start by looking at companies with low price to book ratios.

Until next time,

Brian

Tags: Chinese penny stocks, investing in foreign penny stocks, investing in penny stocks, p/b ratios, penny stocks, price to book ratios, Small cap stocks

Category: Chinese Penny Stocks, Investing in Penny Stocks, Penny Stock Tips