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Ways to Find a Bargain on Wall Street

bws-11The famous Wall Street adage ‘buy low and sell high’ is a favorite among stock brokers and commentators alike, but it is often easier said than done. Just what constitutes low? There are a couple of ways you can ascertain whether something is cheap or not. Searching for those low-priced Wall Street bargains isn’t for everyone but there are solid ways to find a bargain on Wall Street.

P/E Valuation

One of the most popular methods for valuing stocks is to look at the Price Earnings ratio. This ratio measures market price per share divided by annual earnings per share. In other words, it measures the value of a stock in relation to its earnings. But here it gets complicated since different measures use different metrics to calculate earnings, from historical earnings to current earnings, and also projected earnings.

Without getting into the nitty-gritty of P/E valuation, which is a vastly complex subject, the main point is that the higher the P/E ratio, generally the more expensive stock. This is tempered by the fact that stocks with high P/E’s can often be high growth stocks and generally good ones to own.

A better and simpler measure is the Shiller PE ratio which measures valuation for the broader market. Values below historical norms such as 14 indicate the market is cheap and these are generally good times to buy.

Market Cycle

Basic economics teaches us that when something is very cheap people will buy it, reducing the supply, and therefore increasing the price of whatever the thing is. Subsequently, new suppliers will come to the market in order to take advantage of the high prices, which in turn will increase the supply, eventually causing prices to fall back again.

All markets work like this and operate in cycles spanning from a P/E Ratiofew years to long 20-30 year bull and bear runs. Major 20-30 year bull or bear markets are a typical occurrence as it can take long periods of time for new suppliers to come to the market.

Historically, it is rare for a major bull or bear market to last longer than that so if you find a market that has been going down for 20-30 years and has finally started to stabilize, it may indicate the market is very cheap and ready for a new bull cycle.

Scan a chart

Scanning the historical price chart of a security is a quick and easy way to quickly tell whether something is depressed or not. Although it works for stocks too, this method works best for commodities as a commodity will never go to zero (as all commodities have inherent value). A stock on the other hand can go to zero if the company goes bankrupt.

Look for charts where the price has been hovering at historically low prices for a couple of years or more and it‘s a fair bet that a bottom has formed.

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