One of the most challenging tasks of any value investor is to find undervalued stocks to invest in. There are various methods that investors can use to find stocks that are suitable investments. Below are the 9 of the best ways to help investors find mispriced companies.
- Use a stock screener
- Look at what other value investors are buying
- Read the news
- Look within your circle of competence
- What company’s products or services are you passionate about?
- Value Line
- Morningstar
- The scuttlebutt method
- Join a community of investors
Let’s take a deeper look into each of the nine ways and why they are valuable tools for value investors.
1. Use a stock screener
Probably the most efficient way to quickly screen over 5,000 publicly traded companies in the US and the 41,000 listed companies in the world is a stock screener. It is the most efficient way to eliminate large swaths of companies that do not fit your criteria or that you are not interested in. For example, you may know nothing about US healthcare, so you can immediately eliminate that whole sector. Or, you may screen for businesses with a PE ratio below a certain level or a combination of metrics so that a massive list can get relatively small very quickly.
The best stock screener in the world is the Bloomberg terminal. But for those that cannot afford the $2000 per month cost, there is a great free alternative from Finviz– great for value investors because it has a large selection of fundamental and technical criteria.
2. Look at what other value investors are buying
One of the most excellent filters in the world are other well-established value investors. Investors with 20, 30, or, in the case of Warren Buffett, 80 years of experience are highly skilled at spotting opportunities in the market. This doesn’t mean they do not make mistakes; Warren Buffett has made many investment mistakes by investing in the textile industry, and Sir John Templeton has said he was wrong one-third of the time. So even if a well-respected investor makes a purchase, it does not mean it is a sure win. However, it indicates that the company has passed through a thorough filter and has a higher likelihood of being a good bet. You must come to your conclusions before making any investments.
One of the best ways to keep track of what the top investors are buying and selling is to go to Dataroma.com to see their most recent SEC filings or to TIKR.com to see holdings that also include data from shareholder reports for foreign securities.
3. Read the news
A great way to keep track of what is happening worldwide and events that may affect specific industries or companies is to read the news daily. The world is very interconnected, so it is essential to stay up to date with current affairs and track how companies, industries, and countries change over time. This will inform you of past, present, and potential future events. For example, suppose there is a particular company you are interested in. In that case, you can monitor how well the CEO has been making decisions or if the company is continuing to innovate.
The Wall Street Journal is an excellent news source for global affairs and major companies’ significant events. I highly recommend paying the subscription fee for their membership service; the quality of reporting is much higher than anything I can find from a free news source.
4. Look within your circle of competence
Everyone has a circle of competence. Some are very broad, where they are experts in many industries, or very small, where they know a lot about one specific area. Each circle of competence is unique to that person and gives them a slight edge over the majority of the population in their area of expertise. For example, take an engineer who has worked for 30 years developing DRAM memory chips (a memory chip found in most computers). There is a high likelihood that they will know who makes the best chips, each DRAM manufacturer’s competitive advantage, their weaknesses, and the probability of a particular company being a market leader for a long time. The engineer can use this knowledge to their advantage and have a higher likelihood of success when investing in their field.
5. What company’s products or services are you passionate about?
There are products and services you use daily that you enjoy and tell other people about. There is a good chance that millions of other people feel the same way as you do. Take Google, for example; searching the internet via a search engine is “Googling” something. They have 92% of the searches, have the best search algorithms, and are the fastest. Or Apple, which is continuously improving its products and, as such, make the majority of people upgrade their phone every three years. Many of these buyers become ambassadors for the company by encouraging people they know to purchase the products. There is no guarantee that the company’s products or services you are passionate about make it a good company; it is simply an excellent place to start.
6. Value Line
Probably the best quick guide for measuring one business against another is the Value Line numbers. Each page is a summary of a company that includes the past 15-year performance of statistical data, charts, and a description of recent developments, amongst others. It is an efficient way to look at a large number of companies in a short amount of time. They also have a great list of screens such as “Stocks with lowest PEs” and “Worst Performing Stocks of the Past 13 Weeks,” making screening for bargains easier.
However, please pay no attention to the Timeliness Rank (stocks that Value Line says are likely to have the best relative performance); it is their statistical data that is important. You must come up with your conclusions on whether a stock is a great buy or not.
The membership for their base subscription, which includes 600 of the largest public companies, starts at $199.
7. Morningstar
Like Value Line, Morningstar also has an excellent one-page summary of companies called the Morning Star report. They also have analysts’ reports which can sometimes offer specific insights into a company. In the actual value investing style, Morningstar’s analysts favor companies with wide moats and stocks that sell at a discount to a firm’s intrinsic value, which they estimate by forecasting future cash flows. They also have a good stock screener.
Full access to the information mentioned above will cost you $34.95. However, many local libraries offer membership for free. All you have to do is sign up with your local library and sign in using your library card number.
8. The scuttlebutt method
Phil Fisher popularized the Scuttlebutt method in 1957 in his book “Common Stocks and Uncommon Profits”. The technique refers to learning about a company and whether it would make a good investment by talking to people in the company, vendors, competitors, and industry experts. By doing so, you can educate yourself thoroughly before investing. It is actual feet on the street research. It is very similar to being a journalist; you must dig into the company at the same depth journalists do when researching their stories. It is probably the most time-consuming way of research, but it is also the most valuable. There is an advantage over other methods for gathering your information and making decisions based on facts you have obtained. There is a huge emotional component to investing, and staying committed to a good idea is challenging based on unbiased judgments on someone else’s information.
9. Join a community of investors
By seeking out other value investors, you not only get a sense of community, but you also get the chance to exchange ideas. If you find a trusted and respected investor who has your best interest at heart, you can bounce your investment ideas off of them to see if you have any blind spots.
One online community to find undervalued stocks is the Value Investors Club (VIC). Founded by Joel Greenblatt and John Petry in 1999, VIC is an online club where top investors get to share their best. It is an exclusive club where you must submit “a well-researched, well-articulated, attractive value investment idea” to get accepted. However, once accepted, you get access to over 10,000 investment ideas and 130,000 comments on those ideas. Non-members can access the ideas, but there is a 3-month delay after being posted before you can read them.
Final Word
It is important to remember that all the points listed above are just starting points to find undervalued stocks. Once a company is identified, the investor can do an analysis of its financial statements and do more due diligence to understand the company’s moat fully. And, most importantly, the risk (defined as the probability of losing your initial investment).
