Finding the best deep value stocks can be a profitable addition to your diversified portfolio, especially if you target ones with hidden assets

The best deep value stocks are cheap in relation to its sales, earnings or assets. Investors hold onto them because they expect that other investors will recognize their value and push up the share price.

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.

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. We employ three financial ratios as a useful guide to spotting them:

• Price-earnings ratios
• Price-to-book-value ratios
• Price-cash flow ratios

The Profits from Hidden Value Learn everything you need to know in 7 Pro Secrets to Value Investing for a FREE special report for you. Canadian Value Stocks: How to Spot Undervalued Stocks PLUS! Our Top 4 Value Stocks  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

Take a broad view when you look for the best deep value stocks so you can make a more informed decision

When we’re looking for the best investments to recommend in our newsletters and investment services, we start by putting all the important information we know about a company into perspective.

But things are never quite so simple, even with low-risk investments. Your stock pick’s latest earnings may reflect unusually favourable or unfavourable conditions. This can make the company look safer or riskier than it really is. In addition, the company may put the funds it borrowed to immediate profitable use, increasing its earnings and its ability to pay interest. It may plan to sell assets to reduce debt, or cut costs to increase earnings.

In the end, there are many ways to try to put the facts about a company into perspective. None are perfect, since all involve a mental balancing act between high and low estimates, history and the future, and faith versus skepticism.

Take goodwill into account when looking for the best deep value stocks

In analyzing a company’s financial statements, a key concern, and a potential pitfall for investors, is the amount of goodwill that it carries as an asset on its balance sheet. Goodwill is an accounting entry that reflects the price that the company paid for its acquisitions, minus the value of the tangible assets, like land and equipment, that it received as part of the acquisition. The term means “value as a going concern.”

In the right circumstances, goodwill can be extremely important to value stock picks, especially if it is “off-the-books” goodwill—that is, goodwill that a company developed through its own efforts, which does not appear on the balance sheet. Examples include the value of the company’s brand, or the reputation and relationship that it has built up with customers over the years.

On the other hand, if a big acquisition sours, a significant write-down of goodwill or intangibles could hurt the acquirer’s earnings and share price.

Our goal is to put the information in a form that lets us weed out the extremes—excessively overvalued stocks, or those that are suspiciously cheap. In the long run, investors make most of their profits in investments that offer good value and an attractive long-term outlook.

The best deep value stocks will offer you hidden assets

Low-risk investments typically equate to safer investments. For safer investing, focus on high-quality stocks that offer hidden value. As you know, we put a lot of stress on what we call “hidden assets”—assets that are easy to overlook, since their full value rarely appears on a company’s financial statements.

Typically, when we find hidden assets, we find good value stocks. Indeed, some of the value stocks that have done best for our subscribers are well-established stocks that unlocked the hidden value in their real estate holdings, their brand name, the quality of their research or other assets that were not on their balance sheets. This is why we pay special attention to holding company discounts, and spinoffs that frequently reward investors by bringing hidden assets to the fore. As a rule, the deeper the value, the greater the potential for profit.

These assets include long-time real estate holdings that are worth much more than their balance-sheet value (usually original cost minus depreciation). Under-used brand names are another good example. When they are developed in-house, they won’t show any balance-sheet value. Another key hidden asset—one of our favourites—is research spending. Companies write off their research outlays in the year in which they spend the money, but benefits such as new or better products may take years to materialize.

Use our three-part Successful Investor approach to discover the top stocks to invest in, including the best deep value stocks

These three safeguards will tend to limit your losses at the worst of times. But over long periods, they also let you profit nearly automatically.

1. Invest mainly in well-established, mostly dividend-paying companies.
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities).
3. Avoid or downplay stocks in the broker/media limelight.

Is value a main piece to building your portfolio, or is it an afterthought?

What do you look for to help you identify good value stocks for your portfolio?