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Undervalued Stocks: What To Look For

By Edited May 31, 2015 0 0

With the recent problems in the last couple of years in the stock market there has been a resurgence in those looking for value investing. Prior to this there had been an attitude that pursued growth at all costs. When investors lost a great deal of money by seeking growth without a view of the overall picture of the company they began to look for companies that would be "safer." They began looking for undervalued stocks.

Value investing isn't something new. It has been around for quite awhile. However, in the recent extended bull market it was thrown out the window. Investors were looking for extraordinary gains and not merely a steady return. What they didn't realize was that pursuit of extraordinary gains may also lead to extraordinary losses. So they began looking for companies that could participate in a bull market yet not get destroyed should the market turn around and tank. Enter value investing.

Value investing attempts to find undervalued stocks by looking at various different fundamental statistics. If a number of these statistics show as favorable then an investor may conclude that a particular stock is undervalued. They will then take a position and hope it returns to what one would see as its intrinsic value.

Over 70 years ago, Benjamin Graham and David Dodd penned the famous book Security Analysis. In this book was laid out much of what Graham believe about value investing. Years later he revised a formula that he would use to try to locate undervalued stocks. Some of the conditions in the market have changed since then and there are those who question whether Graham's formula would still work today. So many value investors today do not apply a particular formula but they take an overall view of the companies financials and draw their own conclusion. Here are some of the things that they consider.

Dividend Yield. This was one of the greatest tools of value investors from years past. If a company was paying a dividend then the investor knew he was guaranteed at least a certain return every year. Any price accumulation that the company experienced was a plus. However, today not many companies pay dividends. More companies use their money to grow their business further rather than giving it to stockholders. They hope to reward stockholders with an increase in share price.

P/E ratio. The price to earnings ratio is one of the primary tools of the value investor today. How much money are they making in comparison to their stock price? It is difficult to set one P/E ratio for every company in the market. Rather you should compare companies within the same industry and analyze those that have lower P/E ratios than others. If there prospects for growth are the same or greater than their competitors than they may be an undervalued stock and be worthy of further consideration.

Growth rate. Speaking about prospects for growth, this brings us to the next tool for investors. What is the projected 5 year growth rate for the company? Again it would be best to compare this to the industry in which they find themselves. However, if you see a decent growth rate it is possible that the company's stock price may grow near the same rate over this period of time if the company is able to realize that growth rate.

Stay away from debt. Most value investors looking for undervalued stocks will avoid companies with high level of debt. Companies with high level of debt fall into one of two categories. Either they are in financial trouble and they may have difficulty paying their debt service or they are utilizing debt as a way of growing their company. If the latter is true then they would fall more into the category of a growth stock since the more debt they have the greater the risk. Value investors are looking for companies with a low debt to equity ratio. In other words the equity of the company is more than their current debt level. You can find this valuation on most financial websites.

Look for high profit margins. Companies with a low profit margin are viewed as less safe. There are any number of factors that could affect their profit margin if it is very narrow. An interest rate rise or an increase in the cost of the components they use to build their widgets may erase a razor thin profit margin. However, a company with a more comfortable profit margin is able to weather these types of events and still turn a profit.

There are many other factors that an individual looking for undervalued stocks might look at but these will get you moving in the right direction.



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