How can I find undervalued stocks?

Question

I am looking for undervalued stocks. I am 21 years old and I plan to make 26% average anual return over the next 55 years as long long term investor (if there really is the expression 'long long term investor). I know it is extremely difficult as downturn decrease the average annual return on the investment. However, I need to start somewhere. Yet I have invested into stocks with a lower P/E than 10 and a higher capitalisation than 5 billion and historic earning increase.

Answer 1

It takes a lot of research and hard work to be a successful investor. You have to have a lot of sources of information. One site that I think is very useful is http://www.top10traders.com - this is a free site that lets you create a portfolio of stocks with $100,000 in "play" money. Each day the site ranks the best performing portfolios, so you can see how your picks perform compared to other investors. You can read posts on investing from the best traders, as well as share your own investing ideas. There is a charting feature, so you can see how your portfolio performs compared to the S&P 500. Also, you can create your own "group" so that you can see how you are doing compared to your friends.

Here are this month's best traders:

http://www.top10traders.com/Top10Standings.aspx

Good luck.

A couple of great stocks with low PEs: CHK, Chesapeak Energy, a natural gas company, and NBR, Nabors Drilling. I own both.

Answer 2

People who talk about undervalued stocks are misusing efficient market theory (EMT). Why would you buy a stock that's undervalued? Only if you expect it to be fairly valued in the future. What is the instrument that fairly values stocks? An efficient market of course. So given that the market is efficient, why would any stock be undervalued at all?

Undervalued stocks are basically just stocks of companies with a low book value and whose fortunes are not expected to improve very much. When the prospects do improve, the stock gets revalued and the share price goes up and people say that the stock was undervalued before, when they really mean that now its obvious its not a dog anymore.

But value investing is a superior strategy and you can determine that by comparing the price trends of two ETFs, ELV and ELG, value and growth splits of the S&P 500. There's a huge difference. You can also do the same thing with size - compare SPY to MDY to IWM. This small-cap & value outperformance was established in the 1950s by the Fama-French three-factor model.

I would advise you to stop picking stocks and instead select a small-cap value index fund. I think its' very unlikely that you would be able to beat the performance of this fund in the long-term. Small-cap value returns about 12.9% a year. See the IWN ETF price history. FYI 80% of all managed funds lose to the index over a twenty-year history. That shows how difficult it is to reliably pick value stocks and time your purchases. (Ask Bill Miller.) You will also experience higher volatility and transaction costs by active stockpicking.

You may also consider using options for additional leverage for either stocks or index ETFs for greater capital efficiency. (Same results, less capital.) My colleague and I just published an article on that which I'll link to. It also has a lot of info on Indexing and LEAP options.

Answer 3

Well good luck. I think Warren Buffet's record is something like 22%, but somebody's got to beat out everyone else...

I have a personal rule about never buying a stock that hasn't been hammered recently by Wall St. I used to simply buy stocks that I thought were undervalued at whatever they happened to be trading at, and almost invariably the stocks would drop significantly. Often they'd turn around and head in the opposite direction, but that's time and money lost. So every day I check and see what stocks have gone down significantly. A link to a list on MSN is below:

http://moneycentral.msn.com/investor/market/top10.asp?View=Losers&Exchange=ALL

Also if you buy a stock and it seems to go up markedly for no particularly good reason don't be afraid to sell it. The biggest investing mistake I've ever made was sitting on a stock that went up a lot as it came back down.

Good luck.

Answer 4

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