Use these ratios, our tips on spinoffs, and other advice for long-term gains with top undervalued Canadian stocks. Learn more now

Undervalued stocks are companies that typically have strong fundamentals and are trading, for one reason or another, at a low share price.

When you’re looking for cheap stocks—including top undervalued Canadian stocks—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. Undervalued stocks like these are hard to find, even when the markets are down. But when you know what to look for, you can discover them.

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Tips for finding top undervalued Canadian stocks for your portfolio

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 their share prices.

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 ratio—a sign of a cheap or undervalued investment.
  • 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.

Finding the top undervalued Canadian stocks for long-term gains

TSX value stocks are companies that are undervalued, based on a number of measures, on the Toronto Stock Exchange.

Some investors only feel safe buying stocks after prices have risen, which means that they often overlook TSX value stocks. Yet this is the opposite of the way you make most purchases (cars, clothing, etc.) Ordinarily, it’s better to buy when prices go down, not up. When buying stocks, you’ll find this same logic applies.

The first step to finding TSX value stocks is to visit the websites of the companies you are interested in investing in. Get on their mailing lists, and read their quarterly and annual reports. Ask your broker for research reports. Read the business news every day. You’ll be less liable to get caught off guard by price fluctuations and over time you’ll begin to spot the most undervalued stocks in a lineup simply through observation.

In addition to getting to know the companies you invest in, you should also get to know the industries that stocks operate in. Some industries are more volatile than others. Don’t invest in industries you’re not familiar with, and you’ll steer clear of many overvalued stocks.

Consider earnings, dividends and other factors in making decisions. They matter far more than short-term stock-price trends.

Stock prices rise and fall. But strong stocks tend to fall less and rise faster than poor stocks. And don’t overlook top dividend stocks—these companies like to ratchet their dividends upward. Even during market downturns, the last thing a well-established company is likely to do is lower its dividend. When times are good, strong companies will raise their dividends.

Some of the best undervalued Canadian stocks have hidden assets

Typically, when you find hidden assets, you are well on your way to finding 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 names, their research and development, or other assets that were not on their balance sheets at full value.

This is also why we pay special attention to holding-company discounts and spinoffs that reward investors by bringing hidden assets to the fore.

All in all, the deeper the value a stock offers, the greater the potential for profit.

Meanwhile. our search for value begins with our three-part Successful Investor philosophy (see below). 

Top undervalued Canadian stocks can 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.

One group of investors who might be willing to buy a new spinoff are value seekers. And on the whole, it pays to follow the lead of these seekers of undervalued stocks, and to hang on through a period of sluggish trading that can occur when reluctant spinoff holders exercise their urge to sell.

Use our three-part Successful Investor approach to find top undervalued Canadian stocks 

  1. Hold mostly high-quality, dividend-paying stocks.
  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. Downplay or stay out of stocks in the broker/media limelight. 

Some investors believe value investing is dead. Do you agree or disagree?

What do you feel are the keys to finding undervalued stocks?

This post was originally published in November 2021 and is regularly updated.

The term “investment synergy” entered common investor use during the takeover craze of the 1960s — but we see a new synergy that’s a big plus for investors.

The term “synergy” entered common investor use during the takeover craze of the 1960s, when businesses started to expand by taking over companies in unrelated fields. This was supposed to make the combined companies grow faster than if they had stuck to their own fields.

The acquirers borrowed a term from biology to explain their rationale: this mix-rather-than-match growth strategy brought synergistic benefits. Synergy refers to an interaction between two or more drugs. The total effect of the drugs is greater than the sum of the individual effects of each drug if taken separately. For instance, today’s treatments for cancer, prostate and other health issues often call for prescribing two or more drugs. The combined impact may be more powerful and beneficial than you’d expect from adding up what they could do separately.

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However, the synergy effect can also be negative. For example, combining alcohol with tranquilizers or opiates can lead to negative outcomes, even death.

The impact of 1960s investment synergy-seeking growth was uneven. Sometimes it worked, but it was better at producing temporary gains in stock prices than lasting gains in corporate earnings. In later decades, however, it turned out that unwinding synergy-seeking takeovers could lead to even larger profits.

This unwinding broke companies up into a “parent” and one or more “spinoffs.” The parent would then hand out shares in the spinoff to its own shareholders, as a special dividend.

A number of academic researchers have studied the outcome of spinoffs. Most found that spinoffs produce some of the most dependable profits you can find in the stock market, at least for patient investors. The academic findings were so impressive that we called spinoffs “the closest thing to a sure thing that you can find in investing.” (In fact, we were so impressed that it spurred us to launch our Spinoffs & Takeovers newsletter.)

You can find a number of processes in finance and investing that seem vaguely biological or scientific. For instance, consider Moore’s Law. It refers to the 1965 observation made by Gordon Moore (co-founder of Intel Corp.) that the number of transistors in a dense integrated circuit (now called a microprocessor) doubles about every two years. As a result, costs drop by half, and computing speed doubles. (Manufacturing progress later cut that time down to 18 months.)

This high growth rate was due to improvements in the basic design of early transistors. The continuing improvements spurred fast growth in the profits of Intel and other microprocessor stocks, and sharp gains in their stock prices in the 1980s and 1990s. Around 2005, however, the rise in computer processing speed began to slow. Now some bearish analysts predict that Moore’s Law is dead. They say the effect is bound to peter out because microprocessors can only get so small before they quit working. Meanwhile, cramming too many processors on a chip can lead to over-heating.

More optimistic types think that by the time this happens, quantum computing will take over and speed things up again. But it may take a long time for quantum computing to overcome the practical obstacles it faces.

What happens next? Well, before quantum computers come on the market or Moore’s Law runs into a brick wall, AI—Artificial Intelligence—may bring a synergistic boost to computing speeds, and to technological progress in general.

We do not yet know of any stocks we can recommend as buys just for their AI/computing synergies. However, signs of great progress are appearing.

For instance, SingularityHub recently published an article entitled, “AI-Powered Brain Implant Eases Severe Depression With a Zap of Electricity”. Shelley Fan, a neuroscientist-turned-science writer, is the author of the piece. It’s about the work of a research team at the University of California at San Francisco (UCSF), on a device that you might think of as a pacemaker for the brain, for people suffering from clinical depression.

The device can tap into, decipher and alter a depressed person’s moods and emotions, based on the subject’s unique electrical brain signatures.

Brain implants have already helped restore the ability to walk to people with lower-body paralysis, and helped amputees control robotic hands with their thoughts. However, relatively well-defined areas of the outer layer of the brain (the cortex) control physical sensations and movement. This depression-countering device has a harder job. That’s because complex neural networks, deep at the centre of the brain, control emotions and moods. What’s more, these brain networks are personalized.

The UCSF team has so far worked on a single subject, and not an easy one. Sarah is a 36-year-old woman who has struggled with depression since early childhood. She tried all available anti-depressant medications and therapy for decades, and nothing worked. She had not laughed in five years. She quit her job and began contemplating suicide.

Fortunately, however, she got in touch with the UCSF research team and they agreed to give their idea a try.

They implanted 10 electrodes in her brain, to tap into its electrical activity. Over the course of 10 days of study, they learned to recognize signs of depressed feelings, using a method pioneered in the 1980s to treat severe Parkinson’s disease and epilepsy.

With the help of AI, their device quickly learned to detect thought patterns indicating depressive episodes. It also learned to deliver short bursts of electrical stimulation, tailored to disperse these episodes.

When the stimulator was turned on, Sarah reported that “a joyous feeling just washed over me,” even when she wasn’t aware it was on.

Now, three years latter, Sarah has experienced stunning improvement. She has a new job, she has enrolled in a data analytics class, and she is taking care of her elderly mother.

The basic idea seems to be “proven”—but only on one subject. The researchers need to do many more trials before they can think about commercial applications. However, Ms. Fan quotes Dr. Katherine Scangos of UCSF, lead study of the project: “We haven’t been able to do this kind of personalized therapy previously in psychiatry. This success in itself is an incredible advancement in our knowledge of the brain function that underlies mental illness.”

For investors, the key finding is this: the involvement of Artificial Intelligence seemed to enhance the ability of the microprocessors so much that the payoff of computing may continue to expand, even if Moore’s-Law pessimists are right about an inevitable slowdown in computing speed.

Microprocessors-plus-AI is a synergistically powerful combination

It’s true that Sarah’s case may be unique. Or it may take years or decades to duplicate its success. But the big point here may be to recognize that microprocessors-plus-AI is a synergistically powerful combination. It may be just what technology needs to restore Moore’s-Law levels of growth in the speed of computing, and the progress it generates.

No doubt Archimedes was very pleased with himself in the third century BC, when he came up with the three basic simple machines: the lever, the pulley and the screw. Of course, the real fun only began around two thousand years later, with the invention of the steam engine. Maybe something like that is happening today—powered by AI instead of steam.

Everybody knows that many worrisome elements lurk in today’s business-economic-political world. But if you take a broad view of the investment world, and consider the miracles and wonders of today’s technology, things seem brighter.

That’s one reason why we advise you to stick with an optimistic view of the stock market.

What are your thoughts on investment synergy and beyond?

Adding undervalued TSX stocks to your portfolio is a great way to boost your returns over time. There are some key factors you need to watch out for, though, so read on

High-quality “value stocks” are stocks that are reasonably priced, if not cheap, in relation to their 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 undervalued TSX stocks, 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.

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Undervalued TSX stocks are great to find

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,” then hold on to them as their share price rises.

As mentioned, 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, by the way, start out as growth stocks and transition into value stocks.

Use these ratios as a starting point to finding the best TSX value stocks

As more investors come to recognize the worth of these value stocks, they begin to rise. Well-informed investors who recognized the value while the stock lingered at a cheaper price begin to reap the benefits of their foresight.

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

  • Low price-to-earnings ratio—a sign of a cheap or undervalued investment.
  • Low price-to-book-value ratio—another sign that the 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.

Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true worth. 

Here’s how to find undervalued TSX stocks for long-term gains

TSX value stocks are companies that are undervalued, based on a number of measures, on the Toronto Stock Exchange.

Some investors only feel safe buying stocks after prices have risen, which means that they often overlook TSX value stocks. Yet this is the opposite of the way you make most purchases (cars, clothing, etc.) Ordinarily, it’s better to buy when prices go down, not up. When buying stocks, you’ll find this same logic applies.

The first step to finding TSX value stocks is to visit the websites of the companies you are interested in investing in. Get on their mailing lists, and read their quarterly and annual reports. Ask your broker for research reports. Read the business news every day. You’ll be less liable to get caught off guard by price fluctuations and over time you’ll begin to spot the most undervalued stocks in a lineup simply through observation.

In addition to getting to know the companies you invest in, you should also get to know the industries that stocks operate in. Some industries are more volatile than others. Don’t invest in industries you’re not familiar with, and you’ll steer clear of many overvalued stocks.

Consider earnings, dividends and other factors in making decisions. They matter far more than short-term stock-price trends.

Stock prices rise and fall. But strong stocks tend to fall less and rise faster than poor stocks. And don’t overlook top dividend stocks—these companies like to ratchet their dividends upward. Even during market downturns, the last thing a well-established company is likely to do is lower its dividend. When times are good, strong companies will raise their dividends.

Undervalued TSX stocks may 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.

One group of investors who might be willing to buy a new spinoff are value seekers. And 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.

Use our three-part Successful Investor approach to guide you in picking undervalued TSX stocks

  1. Hold mostly high-quality, dividend-paying stocks.
  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. Downplay or stay out of stocks in the broker/media limelight. 

Some investors who follow the Efficient Market Hypothesis (EMH) believe there is no reason to look for undervalued stocks to begin with because all stocks are appropriately priced. What are your opinions on this?

Do you prefer value stocks or growth stocks in your portfolio?

Consolidated Water has expanded into Asia with plants to convert seawater into fresh water

Pat McKeough responds to many personal questions about specific stock advice and other investment topics from the members of his Inner Circle. Below is an excerpt from a past answer to a member’s question on Consolidated Water and its operations that convert seawater into fresh water. We’re re-sharing this past post to highlight our weekly Q&A sessions. While we reserve our buy-hold-sell advice for Inner Circle members, these excerpts provide a great deal of information and analysis on stocks we’ve covered for members of Pat’s Inner Circle.

In this past answer, Pat explains the process of desalination and the advances the industry has already made. He also examines the future prospects for this process and whether the demand for fresh water will lead to strong growth for Consolidated Water.

Q: Hi, Pat. Can I have your thoughts on desalination (seawater into fresh water) and a stock called Consolidated Water? Thanks.

A: Desalination is the process of removing excess salt and other minerals from seawater. It’s also used where saltwater has entered underground freshwater aquifers.

Right now, there are more than 14,500 desalination plants operating in over 120 countries. In all, these facilities produce more than 45.4 billion litres of fresh water a day. About three-quarters of these plants are in the Middle East. That’s because desalination plants are very expensive to build, so they’re only really cost-effective where there is no fresh water. When fresh water is available, it can be pumped up to 1,600 kilometres and still cost less per litre than water from a desalination plant.

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One of the world’s largest desalination plants is the Jebel Ali Desalination Plant in the United Arab Emirates. Converting seawater into fresh water, this facility can produce 829 million litres of water per day. By comparison, one of the largest desalination plants in the U.S. is in Tampa Bay, Florida. That plant can produce 94.6 million litres of water per day.

The most common method of converting seawater into fresh water (now used in around 85% of desalination plants) is flash distillation. In this process, saltwater flows through a series of low-pressure chambers, where it is flash boiled into steam. The steam then condenses on rows of heat exchangers and forms water. Cogeneration plants sometimes use the excess heat from this process to generate electricity. That can cut the overall cost of desalination by up to two-thirds.

Another method, now used in most new desalination plants, is reverse osmosis. This process pressurizes saltwater then forces it through membranes that separate the salt from the water. Reverse osmosis uses less energy than flash distillation. As a result, it has become a more popular means of converting seawater into fresh water as energy costs rise.

Consolidated Water expands to Asia with new project in Bali

Consolidated Water,  symbol CWCO on Nasdaq (www.cwco.com), develops and operates reverse-osmosis seawater desalination plants and water distribution systems where naturally occurring supplies of drinkable water are scarce or nonexistent. Consolidated Water is based in the Cayman Islands and pays no income taxes.

The company owns and operates water production and distribution plants in the Cayman Islands, Belize, the British Virgin Islands, the Bahamas and Bermuda. It also holds a majority ownership of NSC Agua, a Mexican company that is developing a 100-million-gallon-per-day desalination plant near the Mexico-California border. This facility would provide water to southern California and the Baja Peninsula.

The Bahamas is home to the largest projects that Consolidated Water has completed to date. Its Blue Hills plant, which was built in 2005 and expanded in 2013, is the largest diesel-based reverse osmosis desalination plant in the western hemisphere. It has worked closely with the Water and Sewerage Corporation of the Bahamas to develop solutions to improve the availability of potable water for residents in Nassau. The expansion of that facility has eliminated the need to bring water to Nassau in barges in order to meet the growing demand.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members.

Are you willing to invest in a process that is still under development and not widely profitable, like desalination or wind or solar power? Have you had success with any stocks like this?

Have you had any experiences that would discourage you from investing in a similar stock in the future? Let us know what you think.

This article was initially published in 2013.

To profit from growth stocks, you need to pick stocks with clear growth prospects and not simply momentum stocks, including many of today’s AI stocks, with uncertain futures

By definition, growth stocks are companies that have above-average growth prospects. They are firms whose earnings growth has been above the market average, and is likely to remain above average. It is often the case that they pay small dividends or none at all. Instead, they re-invest their cash flow in the business, to promote their growth.

Although these stocks can be highly volatile, they often make good long-term investments. They may be well-known stars or quiet gems, but they do share one common attribute—they are growing at a higher-than-average rate within their industry, or within the market as a whole, for years or decades.

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Understanding two fundamental factors will help you select the growth stocks with the best prospects—and avoid mistakes that can kill your profits:

  1. Know the difference between momentum stocks and growth stocks: It’s very easy to confuse growth stocks with momentum stocks. Like growth stocks, momentum stocks, including many of the “AI stocks” now out there, often move up faster than the market averages. But momentum stocks attract a different kind of investor. Growth-stock investors are in for the long haul, while momentum investors aim to profit from short-term trades and trends like AI stocks. Momentum investors are particularly keen to jump in on a so-called “positive earnings surprise.” That’s when a company outdoes brokers’ earnings estimates.

Momentum investors see a “negative earnings surprise” (or lower-than-expected earnings) as a sell signal. They use a number of formulas to make buy and sell decisions, but all come down to “buy on strength and sell on weakness.” So they tend to pile into the same stocks (including 2024’s hot stock group–AI stocks) all at once, and the gains that follow are something of a self-fulfilling prophecy.

The trouble is that when the stock’s rise wanes, momentum investors also try to get out as a group. But there are never enough buyers to accommodate them. That leads to violent fluctuations in the stock’s price.

  1. Value stocks can lower your portfolio’s volatility: Most successful investors will hold some growth stocks and some value stocks at any given time, depending on where they discover the best opportunities.

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

    Together, growth stocks and value stocks can form a winning combination. A growth stock can be a top performer while the company is growing. However, a single quarter of bad earnings can send it into a deep, though often temporary, slide. Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

If you invest as we advise—by spreading your investments across the five main economic sectors, investing mainly in well-established companies and staying away from stocks in the broker/media limelight—you will automatically own some growth stocks and some value stocks.

That helps you achieve good results while decreasing volatility. In the end, however, the relative amounts that you invest in growth stocks versus value stocks are less important than your portfolio’s diversification and overall investment quality.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members.

When you buy a growth stock, do you plan to keep it for the long term as it grows bigger, or are you simply looking at taking profits after the stock has a growth spurt? Are you willing to hold stocks like these when the share price takes a dip, as many supposed AI stocks are likely to? Let us know what you think.

This article was originally published in 2012 and is regularly updated.

Investing in the best growing stocks will put you in a position to make significant gains, but it comes with risk as well. Follow our tips to make smarter—and safer—picks

High-quality growth-oriented stocks can be worthwhile additions to most well-diversified portfolios. Although these best growing stocks can be highly volatile, they can make good long-term investments.

There’s room for growth stock investing in your portfolio, but make sure you follow our TSI Network three-part Successful Investor strategy for your overall portfolio.

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Understand these characteristics of the best growing stocks so you can make informed investment choices

Top growth stocks have hidden assets that can make a big difference long-term. Hidden assets can make a huge difference in growth stocks. They are also a key part of our Successful Investor approach. One example of hidden assets is real estate.

Another example of hidden assets is research and development spending. Technology companies spend large sums of money developing new practices and technologies that can change the world of the future. This research may not pay off for decades, but if you’re a savvy investor, you can see via their income statements what companies spend on research and development.

Top growth stocks should be free of high debt. When you’re researching growth stocks, you need to know how much debt they’re holding. Growth companies with a lot of debt have a hard time recovering from an economic downturn.

The more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first. That’s especially true for ones that also keep trying to allocate part of their cash flow to paying dividends.

Top growth stocks will typically be multi-product companies. Technological advances, for example, come in spurts and tech companies tend to leapfrog each other. Focus on tech growth stocks with a variety of existing or soon-to-be-released products and avoid one-hit wonders. 

Growth stocks to invest in often focus on up-and-coming technologies. For this, you need to know how technology is changing. Read and absorb the latest tech blogs. Learn about the technologies that are exciting tech companies. For instance, ever-increasing use of wireless devices is raising demand for faster and faster, reliable wireless networks such as 5G. 

Illiquid or “thin trading” stocks are rarely good examples of the best growing stocks 

You compound your risk if you invest in a promising junior that is a “thin” or illiquid trader. When a stock is a thin trader, it doesn’t take much buying or selling to influence its price. So if just one important investor decides to sell, it can cause an abrupt stock-price slump. This can spark a cascade of selling and a collapse in the stock’s price. The resulting stock downturn can scare off other potential investors. This can make it impossible for the formerly promising junior to raise additional funds when it needs them.

Investors in start-up companies also face one overriding, continual risk: it’s easier to launch a promising company than to create a successful business. That’s why only a minority of fast growing stocks ever go on to significant success.

Avoid selling your best growing stocks too early and keep gains in your portfolio

It’s all too easy to sell a stock that looks like it’s headed for a downturn, only to buy another that is headed for a collapse. For that matter, if you make a habit of selling whenever you feel the market’s risk has gone up, you will wind up selling your best stocks way too early.

You can always find a reason to sell. Market commentators are continually thinking up new ones, based on recent market strength or weakness, historical market patterns, political or economic predictions, changes in tax policies—the list is endless. This is a good thing. After all, you can only buy a stock if somebody who owns it wants to sell.

Before you act on a selling rationale, take a broader look. Consider facts about the stock, and about your investment goals and temperament. If the selling rationale makes sense and you find additional good reasons to sell, then selling may be the right thing to do. But it’s always a bad idea to sell a good stock for trivial or transitory reasons.

Minimize your risk with the best growing stocks by using our advice, in addition to our Successful Investor approach mentioned below

When we look for aggressive investments, we zero in on companies that have established a business and have at least some history of building revenue and cash flow. We also look for companies that stand to benefit as the economy continues to improve, and have proven management and long-term growth plans.

Because aggressive stocks expose you to a greater risk of loss, we recommend limiting your aggressive holdings to a limited part of your overall portfolio.

Use our three-part Successful Investor approach to discover the best stocks to invest in

  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. 

Are growing stocks a major focus of yours, or do you prefer to find stocks that are already established?

What characteristics do you look for in growth stocks?

Here’s how our “hold” advice fits into our recommend stocks—and some bonus tips on penny stock investing

We continually scour the Canadian and U.S. markets for stocks to recommend as buys to our clients. We generally get excited about only a handful—that is, excited enough to list recommended stocks as buys in our publications.

Most stocks we look at have one or more serious flaws, in our view. If you ask about stocks like these, we’ll tell you to sell.

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If we say a stock is “okay to hold,” it doesn’t mean it’s one of our recommended stocks

A large number of stocks that we look at for our Inner Circle members fall into a grey area. We wouldn’t advise buying them, but they are “okay to hold,” in our view. We just don’t feel strongly enough about these stocks to advise buying.

Of course, they may feel more positive about some of our okay-to-hold stocks than we do. If the Inner Circle members want to buy them for their portfolios, we can’t voice any strong objection. We simply don’t share their enthusiasm. We feel they’ll find better choices among the buys we currently recommend in our newsletters.

Note that when we say “okay to hold” in our Inner Circle advice, we mean something substantially different from when we recommend a stock as a “hold” in our newsletters or Hotlines. In our newsletters and Hotlines, it means we recommended the stock as a buy in the past, and we may recommend buying it again in the future. But at the moment, we see better choices for new buying elsewhere in the newsletter.

Here too, however, you need to apply our advice to your own situation.

Look to our “holds” if you want something to sell to switch into one of our recommended stocks

If you mostly own stocks we see as “holds,” you should consider selling some of them and replacing them with stocks we see as buys. Of course, before you sell, you need to consider any capital gains tax liability that the sale will involve. You’ll need to weigh that tax cost against the benefit that the transaction will bring to your portfolio. You’ll also need to consider the effect that the sale of one stock and buying of another will have on your portfolio. You’ll need to consider how well the revised portfolio lines up with your resources, goals and temperament.

The complications are endless, but the basic rule is simple. When you own good stocks, it generally pays to hold on until you have a good reason to sell. When you own mediocre or speculative or bad stocks, the reverse is true. It generally pays to sell unless you see a good reason to hang on.

Penny stocks are not typically among our recommended stocks

Penny stocks can be riskier than other investments. Investors looking to add to the aggressive portion of their portfolios may turn to the higher-risk strategy of buying speculative penny stocks.

However, there are several potential risks when investors venture into penny stocks.

Buying low-quality Canadian penny stocks is one of those things that can appear to be successful before it goes badly wrong. Some get hooked on it, since low-quality stocks can be highly profitable over short periods. That’s because they are generally more volatile than high-quality stocks.

Pennies aren’t usually among our recommended stocks because the odds of success are against you

However, if you lose money in speculative pennies or other low-quality stocks, you may think your main mistake was bad timing. That’s a misconception. All penny stocks rely on luck to become wildly profitable. If you play long enough, the “house odds” eventually triumph over any run of luck.

In penny stocks or games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose.

That’s also why we think you should apply our sell-half rule.

Selling half your holdings after you double your earnings is a good strategy for any high-risk investment, but especially so for penny stocks.

This can give you a clearer perspective on what to do with the other half of your investment. After all, if you are too slow to sell speculative stuff, your profits and even your principal can evaporate all too quickly.

While penny stocks can be a worthwhile addition to the aggressive portion of a diversified portfolio, you should in general only buy them with money you’re willing to lose.

Penny stocks are only one kind of aggressive and speculative investments. What type of investments do you look for when adding to the aggressive section of your portfolio?

Penny stocks can pay off, and give investors a rush, but they don’t make good long term investments. Would you agree? Or is there a time when penny stocks can be good for long term gains?

Unlike Canadian value stocks, investing in a value trap, even though it may seem like a good deal, is a mistake to avoid

The meaning of “screaming buy” is different for every investor. Some use it when they think a stock (oftentimes perceived as Canadian value stocks) is virtually certain to go way up in a hurry when the market comes to its senses. A stock may seem like a screaming buy to some investors if it has gone up a great deal on good news, and the good news seems likely to continue. It may also seem like a screaming buy if it has dropped a great deal, and the drop seems out of proportion to whatever bad news seems to have caused the drop.

“Value trap” is much more specific. The term suggests that stocks look like Canadian value stocks, say, based perhaps on statistical measures, but that they are likely to get much cheaper. Those stocks may have an unusually high dividend yield, an unusually low p/e (per-share price-to-earnings ratio), a low ratio of stock price to book value, or any of several other conventional signs of per-share value.

Any of these measures can make it seem like a stock is a bargain–Canadian value stocks. But in fact, any of them can simply be due to a low stock price that is the result of selling by well-informed investors who recognize a dismal long-term future.

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Going deeper into the concepts of screaming buy and the value trap

Successful investors find use for the term “screaming buy” rarely—every few years, if that. That’s because they’ve learned from experience that in the stock market, things are never certain. That’s why we always advise you use our Successful Investor approach to build a balanced, diversified portfolio of high-quality stocks. That makes it easier to spot Canadian value stocks when they do emerge.

A value trap can make a stock look like a bargain. But in fact, a stock may be statistically cheap as a result of selling by insiders or well-informed investors who recognize its dismal long-term future.

Too much reliance on simple value measures alone in stock analysis can lead you into a costly value trap

You need an eye for value to be a Successful Investor. But focusing on value measures alone can steer you into unsuccessful investments that are sometimes referred to as “value traps.”

Another way to fall into a value trap is to put too much faith in the value of a brand name. A strong brand can sell a lot of a strong product, or keep an over-the-hill product going long after competitors have faded. But even the strongest brand name can only do so much.

4 tips for avoiding value traps (and finding Canadian value stocks):

  1. Determine if the company has freedom from business cycles? Demand periodically dries up in “cyclical” businesses such as resources and manufacturing. You can hold some value stocks from those sectors, but look as well for companies, especially in manufacturing, that have broad product lines or products that are indispensable.
  2. Review a company’s dividend record over the last 5 to 10 years. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying stocks, you’ll avoid most frauds.
  3. Review a company’s finances going back 5 to 10 years. The types of investments we focus on have a history of profits going back for at least that long. Companies that make money regularly are safer than chronic or even occasional money losers.
  4. Determine if the company has hidden asset in their relationship with loyal customers. After a series of satisfactory dealings, long-time customers develop a level of trust that makes them receptive to related offerings from the company. This customer loyalty can help businesses mitigate the value trap.

Bonus Tip: A big or key idea may lead investors into another kind of trap

Many investors instinctively try to spot these big ideas. Most instead get sidetracked by ideas that are eye-catching but transitory. Rather than give you a clue to the market’s direction, these transitory ideas may distract you from what’s really going on. For example, when markets rise for a long time, some investors lose the habit of trying to spot the big ideas that are driving the rise. Instead they switch to searching for what you might call “The One Big Signal” that tells you it’s time to sell. You’re especially prone to falling into this trap if you’ve stayed out of the market during a long rise in prices.

How have you been able to distinguish between true Canadian value stocks vs value traps?

How much of your portfolio have you lost in value traps since you began investing?

The best Canadian stocks will have the investment quality your portfolio needs over the long term

There are a variety of reasons why you should add some of the best Canadian stocks to a Successful Investor-style portfolio. Most important, the stocks to buy and hold in your portfolio all have one thing in common: They give you reason to believe they might be worth holding on to indefinitely.

We feel most investors should hold a substantial portion of their investment portfolios in securities from blue chip companies. The best of these stocks should offer good “value”—that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above-average growth prospects, compared to alternative investments.

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Learn how you can find the best Canadian stocks using our Successful Investor guidelines

We believe that high-quality stocks are your best protection in a portfolio, especially given the economic uncertainty tied to the continuing COVID-19 pandemic. To find those stocks, and build a sound portfolio, start with our Successful Investor philosophy:

  1. Invest mainly in high-quality, well-established companies, with a history of earnings if not dividends;
  2. Diversify across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
  3. Downplay or stay out of stocks that are in the broker/media limelight.

“Buy and hold” is a bad way to describe what we recommend. We prefer “buy and watch closely.” But we still think frequent trading is apt to make money only for your broker.

In short, our strategy focuses on the concept of “buy and watch closely.”

Obviously, it is easier to hold high-quality stocks that perform well over time. But we do not recommend that you hold indefinitely.

We advise selling particular stocks when we feel the situation has changed and they no longer qualify as high-quality investments. We also sell if we decide that a stock isn’t as high-quality or well-established as it needs to be to cope with the challenges it faces. Of course, many of our sales are due to a successful takeover of a company’s stock, which generally results in a major profit.

Buy blue chip stocks if you want to add some of the best Canadian stocks to your portfolio

A company with a long-term record of paying dividends is generally one that is most deserving of the “blue chip” label in its traditional sense. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.

The best blue chips offer both capital gains growth potential and regular dividend income. The dividend yield is certainly one of the most concrete indicators of a sound investment. It is the percentage you get when you divide the current yearly dividend payment by the share or unit price of the investment. It’s an indicator we pay especially close attention to when we select stocks to recommend in our investment newsletters.

Keep in mind that when you are buying the best Canadian stocks, you should not expect to pay lower than market prices

For many investors, buying stocks involves a two-part decision. First, they decide which ones to buy, then they decide what price they want to pay. Most want to buy, say, 5% to 10% below current prices.

These investors often explain that they are simply looking to buy stocks like a smart consumer buys a car. However, the stock market is more efficient than the car market, as an economist would put it. To get a lower price on a stock, you have to wait for its price to come down.

If you always try to buy below the market, you’ll always get a “fill” on stocks with hidden flaws. They’ll always come down into your buying range … and they’ll keep on falling.

But you’ll never get to buy the other kind of stock—the kind that keeps going up. They’ll always seem too expensive, and they’ll go on to get even more expensive. But you need a few of these ever-more expensive stocks to offset the losses from those that get cheaper and cheaper.

Download this free report now to find the best stocks to keep in your portfolio.

Bonus Tip: Find out how to place orders with your broker for the best Canadian stocks

When buying stocks, most investors place “market orders” or “limit orders.”  However, which is the better form of order? It’s a decision many investors have to make each time they buy a stock.

When you understand the use of market and limit orders, you can improve the profitability of your stock investments.

For most investors, market orders are a better approach than limit orders.

A market order is an order to buy or sell a specific number of shares at the best price available when you place your order. In contrast to limit orders, market orders are almost always filled within a very short period of time—in minutes, if not seconds.

However, you only learn the price you paid (for a purchase) or received (for a sale) after the order is filled. The market price may change, for or against you, between the time you place the order and when it is filled.

In general, Successful Investors should use market orders when buying or selling widely traded shares. That’s because the market-order risk of occasionally paying too much is more than offset by the limit-order risk of missing out on your best ideas.

What are some of the best Canadian stocks you’ve added to your portfolio? How did you recognize them as good additions?

This article was originally published in 2018 and is regularly updated.

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The contents of this web site and our publications are based upon sources of information believed to be reliable, but no warranty or representation, expressed or implied, is given as to their accuracy or completeness. Any opinion reflects the Successful Investor’s judgment at the date of publication and neither the Successful Investor, nor any of its affiliated companies, nor any of their officers, directors or employees, accepts any responsibility in respect of the information or recommendations contained in the publications or on this web site. Moreover, the information or recommendations are subject to change without notice.

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