Topic: Value Stocks

How to Pick The Best Undervalued Stocks Today—For a Richer Tomorrow

If you want to find undervalued stocks today with the most promising future, here’s how to do it.

When you look for the best undervalued stocks today, 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.

High-quality value stocks like these are difficult to find, even when the markets are down. But when you know what stocks to look for, you can discover them.

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How to find undervalued stocks today using your brain and not your emotions

Market pessimism can let you find some undervalued gems—stocks that drop along with the market as a whole yet still have sound fundamentals. But one of the sweetest and most profitable pleasures of successful investing is to buy high-quality “value stocks” (or stocks that are reasonably priced, if not cheap, in relation to their sales, earnings or assets), then hold on to them as investors recognize the value and push up the share price.

Value stocks are typically stocks trading lower than their financial fundamentals suggest. They are perceived as undervalued, and have the potential to rise. Many new tech stocks, for instance, start out as growth stocks and transition into value stocks.

When they look for value stocks to buy, investors usually start by looking at a few basic ratios. For example:

Low price-to-earnings and price-to-book ratios—signs of cheap or undervalued investments.

Low price-to-book-value ratio—another sign that a stock is cheap in relation to other stocks on the market.

High dividend yield—the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.

Be aware that top value stocks may only be cheap due to hidden problems

If a stock seems like an exceptional bargain in relation to earnings or asset values, it may suffer from hidden risks. The stock can plunge when those problems begin to take their toll.

Academic studies suggest that on average, value investing produces better results than growth investing. But these studies mostly look back on what would have happened in a particular historical period if you followed a particular set of rules. Most distinguish between growth and income investing by looking at average p/e’s (the per-share-price to per-share earnings ratios). They assume high p/e’s are a marker for growth stocks and low p/e’s for value stocks. As any serious value or growth investor can tell you, it’s more complicated than that.

If you balance and diversify your portfolio as we recommend, it should include both growth and value selections. In both areas, you should avoid extremes.

Undervalued stocks today include spinoffs

When a spinoff begins trading, it stands to reason that investors will put a low price on it. After all, the spinoff hits the market with a large number of neutral, if not reluctant, stockholders who have limited expectations for it, and who are willing to sell when they get around to it. Moreover, there is often little, if any, brokerage research available on the new company.

The only investors who might be willing to buy a new spinoff are those who have taken the trouble to read the voluminous material that companies hand out as part of the spinoff process. But on the whole, it pays to follow the lead of these seekers of undervalued stocks, and to hang on through months of sluggish trading while reluctant spinoff holders exercise their urge to sell.

Bonus Tip: “Dollar cost averaging” is a great way to buy undervalued stocks today and tomorrow

When you find what you feel are the most undervalued stocks, consider investing at least some of your funds by practicing “dollar cost averaging.” Invest the same dollar amount on a regular basis. That way you’ll buy more shares when prices are low, and fewer when they’re high.

In fact, if you invest a fixed sum at regular intervals throughout your working years, perhaps increasing that sum from time to time as your income rises, you can largely forget about market trends. If you factor in dividend payments, dollar cost averaging could make a huge difference to your long term profits.

Undervalued stocks with extremely high dividend yields could be a danger sign. How do you decide what to do with investments like this?

Have you ever sold an undervalued stock before it rose because you thought it wasn’t going anywhere? What would you do next time?


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