Investing in low-price high-quality stocks can help investors make more money over longer periods of time. Often, that’s because of hidden assets such as real estate or brand loyalty
Low-price, high-quality stocks are typically stocks trading at prices below what their fundamentals such as earnings, cash flow, low debt, and so on, would suggest. They may also carry undervalued assets on their balance sheets, hold large patent portfolios or spend high amounts on research and development that will yield future benefits.
These stocks may also have other hidden assets in the form of their relationships with loyal customers or the hidden value of real estate they’ve purchased in the past. For instance, when a company buys real estate, the purchase price goes on its balance sheet as the value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. But the historical purchase price remains unchanged on the balance sheet.
The Profits from Hidden Value
Learn everything you need to know in '7 Secrets to Unlocking Value Stocks' for FREE from The Successful Investor.
Canadian Value Stocks: How to Spot Undervalued Stocks Plus Our Top 4 Value Stock Picks and more.
Here’s how to find low-price, high-quality stocks to add to your portfolio
Virtually all successful investors have some form of a value investing strategy, at least for a portion of their portfolio.
Many successful investors also have some knowledge of technical analysis, and most have some knowledge of a variety of other tools and shortcuts. But almost all successful investors take a broad view, and apply everything they know to their investing decisions.
When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele. Furthermore, we recommend using a few basic ratios.
Low price-to-earnings and price-to-book ratios may be signs of cheap or undervalued investments.
Low price-to-book-value ratio is another sign that a stock is cheap in relation to other stocks on the market.
Dividend yield is the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.
Practice patience with low-price, high-quality stocks and you could profit as their value increases
As more investors come to recognize the value of so-called undervalued stock picks, they begin to rise. Well-informed investors who recognized the value when the stock price was lower benefit from that rise.
It is best to practice patience with your investments, especially value stocks. All too often, investors buy a promising stock just as it enters a period of price stagnation. Even the best-performing stocks run into these unpredictable phases from time to time. They move mainly sideways in a wide range for months or years before their next big rise begins. (Stock brokers often refer to these stocks as “dead money.”)
If you lack patience, you run a big risk of selling your best choices in the midst of one of these phases, prior to the next big move upward. If you lose patience and sell, you are particularly likely to do so in the low end of the trading range, when stock prices have weakened and confidence in the stock has waned.
Beware of seemingly desirable low-price, high-quality stocks and you may save your portfolio from hidden risks
Suppose you decide you will only consider buying stocks with a per-share price-to-earnings ratio of 10.0 or less. That way, you hope to get more earnings for each dollar you invest. But the “e” or earnings in the p/e only covers earnings, or an earnings estimate, for a single year. The year your stock’s low p/e looks attractive may coincide with a peak in the company’s earnings, for any number of reasons.
One key reason is that many disasters-in-waiting go through a low-p/e period prior to their eventual collapse. During this low-p/e period, people close to or involved with the company recognize that it has serious problems. They sell their own holdings and they tell their friends and relations to do the same.
Another common problem is that the company is cyclical and is at the top of its business cycle—and its earnings are at a peak. (It’s easy to overlook the fact that tech stocks tend to be cyclical. Their growth can mask the typical peaks-and-valleys of a business cycle.)
In contrast, specific reasons why a company’s profit may slump for one or more years include the expiration of a patent, new competitors, a rise in costs, adverse legal or regulatory changes, or investigations for illegal activity.
As the saying goes, a low p/e may signal danger rather than a bargain. Note, however, that staying out of all high-p/e stocks can also hurt your results.
Use our three-part Successful Investor approach to select low-price high-quality stocks
Hold mostly high-quality, dividend-paying stocks.
Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
Downplay or stay out of stocks in the broker/media limelight.
Have you ever mistaken a low-price stock for a high-quality investment when it was a marketing scam or penny stock in disguise? What happened with your holding?
What is your strategy for finding low-price, high-quality stocks?
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