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5-Point Checklist to Finding an Undervalued Stock

5-Point Checklist to Finding an Undervalued Stock

If you could buy a $100 bill for $80, wouldn’t you jump at the chance to do so? 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.

Understand why stocks become undervalued

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:

  • Missed expectations: If a stock reports quarterly results that fall short of expectations, shares can drop more than the situation calls for.
  • Market crashes and corrections: If the entire market drops, it’s a great time to look for undervalued stocks.
  • Bad news: Just like when a stock misses analysts’ expectations, a bad news item can cause a knee-jerk reaction, sending shares plunging more than they should.
  • Cyclical fluctuations: Certain sectors tend to perform better at different stages of the economic cycle. Sectors that are out of favor are good places to look for bargains.

Only look at businesses you understand

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.

Know the metrics

There are dozens of metrics you can use to evaluate a stock, but the following are some of the best for locating undervalued stocks:

  • Price-to-earnings (P/E) ratio: By dividing a stock’s current share price by its annual earnings, you can calculate this metric, which is useful for comparing companies in the same business. A lower P/E means a stock is “cheaper,” but this is just one variable to consider.
  • Price-to-book (P/B) ratio: Calculated by dividing a stock’s price by its equity per share. A book value of less than one implies that the stock is trading for less than the value of a business’s assets. Value investors use P/B multiples to find stocks with a margin of safety.
  • Price-to-earnings to growth (PEG): Found by dividing a stock’s P/E ratio by its projected earnings growth rate over a certain time period — typically the next five years. This can be effective for assessing the valuation of a company with a seemingly high P/E, but whose earnings are growing rapidly.
  • Return on equity (ROE): A company’s annualized net income as a percentage of shareholders’ equity. This is a measure of how efficiently a company is using invested capital to generate profits.
  • Debt-to-equity ratio: As the name implies, this is calculated by dividing a company’s total debt by its shareholders’ equity.
  • Current ratio: A liquidity metric calculated by dividing a company’s current assets by its current liabilities. This tells investors how easily a company can pay its short-term obligations.

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. For example, when I’m hunting for a good value, I like to see a below-average P/E for the stock’s peer group, a debt-to-equity ratio of 0.5 or less, and ROE of 15% or higher. Note that these aren’t set-in-stone guidelines. Rather, they are one piece of the puzzle that should be taken into consideration.

Go beyond the numbers

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 effici

ency, 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. 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.

A final rule

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.

Financial Freedom

Financial Freedom

The FED Pushed the Dollar into Overdrive on Wednesday, EUR/USD at its Lowest in 14 Years

Author: Eric Furstenberg/Thursday, December 15, 2016/Categories: Daily Opportunities

I like it when the market makes big moves. It’s always easier to make money in a trending market than in a range-bound market. I hope you stayed on the right side of the prevailing trends today, and you must have made some profits if you held long dollar exposure. You see, trading financial instruments becomes much easier as soon as you align yourself with the prevailing trends. The trend is your friend. That is something that will never change.


I’m excited about the multi-year lows that were set by the EUR/USD today. Before Thursday, this pair traded in a wide range of about 1200 pips for almost two years. So finally we have a fresh low to work with. The 2015 low, which was broken on Thursday, was a very significant technical level. You can know for sure that every fund manager and every currency trading institution in the world has taken note of what happened in the EUR/USD today. Let’s look at a few charts:

EUR/USD Daily Chart

Thursday’s trading volume on the EUR/USD was above average. Volume is very important in trading. High trading volume is often an important confirmation of trend direction. Let’s take this last daily bar as an example. The candle was a large bearish one which closed close to its low. The volume was above average which tells us that there will probably be some follow through selling in the days to come. Of course, there could be a pause or a weak retracement, but the probability of the pair moving lower over the course of the next two weeks is very high.

Some traders like to trade the initial break of a significant level. Others prefer to wait for a breakout-retest setup before entering. Then you get traders who split their position between the two. The breakout has already occurred, so we need to wait for a retracement to achieve the most optimal short entry. Have you ever wondered where the big boys park their orders? Look at the following chart:

EUR/USD Daily Chart

Look at the green entry zone on this chart. There are definitely a bunch of large sell orders lying in this region. If we get a retracement into this zone, it could be a great opportunity to enter short. The horizontal black line is at 1.04624, which is the 2015 low.

Parity. A small word, but a massive psychological level for the EUR/USD. With Thursday’s important technical break, parity is the next major level ahead. If the current US dollar strength persists, the 1.0000 level could soon be on the cards. The Eurozone still faces many economic and political risks which could put further pressure on the Euro, and of course, on the EUR/USD.

I’m currently holding short exposure on the EUR/USD and I would like to add some more short positions if we get a run-up into the zones mentioned in the chart above. The EUR/USD is not the only pair with great potential, though. Let’s look at the AUD/USD:


AUD/USD Daily Chart

I have been eyeing this resistance zone for quite a while now. This resistance zone, backed by the 200-day moving average, was just too much for the bulls to overcome. The impulsive decline over the last two days compels us to choose the short side on this pair. I am already short on the AUD/USD, and I think we still have much downside available on this pair.

Of course, there are many other pairs with much potential. On Wednesday evening and on Thursday, I played long positions on the USD/CAD, USD/CHF, USD/JPY, other Yen crosses, and the DAX. I also sold gold for a juicy intraday profit. As mentioned above, I am also short EUR/USD and AUD/USD. The trends on these instruments could easily provide some more profits in the days ahead, so keep an eye open for opportunities on them.