Buying undervalued stocks
Founded in by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services. While value investing is a little more complex than that, it's the general concept behind finding undervalued stocks for your portfolio.
This sounds like a great idea in principle, but how do you find these amazing bargains? Here's a list of five steps to take in order to find undervalued stocks of your own. One of the central ideas of value investing is that the market misprices stocks from time to time.
There are many potential reasons why a stock can become undervalued, but these are a few of the more common ones:. This should go without saying, but too many investors buy shares of companies without really knowing how they make their money or having a grasp on the overall business dynamics of the industry.
As a rule when searching for undervalued companies, I highly recommend narrowing your search for undervalued stocks to the types of businesses you understand. For example, I have a strong understanding of the banking industry, as well as real estate, energy, and consumer goods, so stocks in those industries make up the majority of my portfolio.
On the other hand, I really don't have a good grasp on the biotech industry so I simply won't invest in it. Don't get me wrong -- I'm sure there are a lot of great companies in biotech, and many could indeed be undervalued right now, but it's just not my area of expertise.
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There are dozens of metrics you can use to evaluate a stock, but the following are some of the best for locating undervalued stocks:. Once you start evaluating stocks and getting a feel for these metrics, it's a good idea to develop your own criteria for identifying a stock as undervalued.
Note that these aren't set-in-stone guidelines. Rather, they are one piece of the puzzle that should be taken into consideration. These metrics are a great place to start, but there are other things to look at that can be indicative of an undervalued stock.
For example, one of Warren Buffett's criteria is that a company has a "wide economic moat," which means a sustainable competitive advantage that should protect it from economic downturns as well as from its competitors.
Wal-Mart is an excellent example of a company with a wide moat. Thanks to its size and efficiency, it can undercut most other retailers. Therefore, when times get tough and people need to save money, Wal-Mart actually gets more customers. All other things being equal, a company with a wide moat is considerably more valuable that a company without one.
Insider buying and selling is another thing to look at.
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Basically, if company insiders hold large stakes and are buying more shares, it's a good sign that people on the inside feel there's a good value to be had. While this isn't a foolproof indicator, it's certainly worth looking at. The final rule for finding undervalued stocks is to be patient. Sometimes the overall market gets expensive and none of the companies you follow will seem to be trading for attractive values, and that's OK. Bargains will come, so if you can't find an undervalued stock, don't force an investment that you'll later regret.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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The Motley Fool has a disclosure policy. Matt brought his love of teaching and investing to the Fool in in order to help people invest better. Matt specializes in writing about the best opportunities in bank stocks, REITs, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!
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