Howe to Find Undervalued Stocks

Value investing has come back in vogue in the last couple of years due to the market debacle of 2008 and early 2009.  Value investing is simply looking for stocks that may be trading beneath what is their perceived intrinsic value.  In other words, they are undervalued stocks.  When the market collapsed investors began to realize that they needed a little more safety than their current portfolio was providing them.   This made value investing a particularly good fit for these individuals. 

Value investors attempt to find undervalued stocks that may give them good upside potential when the market moves upward but provide them a little protection when the market moves lower.  The thought process is that since these stocks are undervalued to begin with that they will not move down as much as the rest of market. 

There are a number of fundamental factors that value investors consider when looking for these undervalued stocks.  Here are a few of them.

Companies with a high level of debt present problems to investors, especially in a difficult economic environment.  High levels of debt may require heavy amounts of operating capital to pay down debt service.  This can make the difference between turning a profit and reporting a loss.  Value investors are looking for companies with cash on hand and very little debt.  You can hunt down the debt to equity ratios at most financial websites.  Look for values of less than 1.  The lower the better.

Probably the most well known valuation tool is the P/E ratio.  This is simply the trailing 12 months earnings of the stock divided by the price.  Low P/E/ stocks may present value plays.  Do not compare the P/E of the stock under consideration to the overall market.  Instead compare it within its own industry.  This will be you a better reading of what you should expect.  If it is trading at less than the industry average then it might be an investment opportunity.  Of course, a low P/E may also be a sign of trouble.  Look to see if the company is expected to make money this year.  If it is and especially if it is expected to make more than it made in the previous year then you probably have a good candidate on your hands. 

You need to be careful with this particular factor but it looked at correctly may provide a good return.  If you find a stock that meets many of the different criteria that you are looking for finding a value stock then you may want to take a look at the volume as well.  If the volume is low it may indicate that not many investors have discovered this yet.  However, as others begin to perceive this as a value play then the volume will increase.  As the volume increases the price is also likely to increase.  However, be careful to not purchase illiquid stocks.  By small volume I would be viewing stocks trading between 150,000 and 500,000 shares.  

Another tell tale indicator is if you find a stock that meets the above criteria and has a promising 5 year expected growth rate then you may have found a stock to trust some money to.  I would look for companies who are expecting at least 10% growth each year.  If you can find such a company then do some more homework to determine if they may be a fit.

Stocks become undervalued frequently.  This occurs especially if there was a market selloff.  Even good stocks with promising futures get punished when the market collapses.  You may want to make a list of undervalued stocks and then look for Mr. Market to punish them at some point.  This way you will keep an eye on a few potential and promising stocks.