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I answer this question by calculating a stock's value from its earnings growth rate, profitability and other fundamentals. My formulas for calculating value are described in Chapter 3 of my book, "Stocks, Strategies & Common Sense.” Click here to get it FREE. If a stock's Value is more than its Price, the stock is undervalued. It's a candidate for selection.
Undervalued stocks offer a higher probability of achieving gains, the potential for very large gains and lower downside risk. In other words, undervalued stocks increase the odds of winning, increase the rewards for winning and decrease the risk of losing compared to overvalued stocks. So, favor undervalued stocks.
Rule II:
Favor Safe Stocks. Have you ever noticed that the prices of stocks like Coca Cola and McDonalds never seem to cause any excitement, yet go up year after year? Stocks like Chrysler are always in the news, and go up and down like a yo-yo. There's a very simple reason for this contrast. The former have track records of steady earnings performance while the latter has an erratic earnings record. Price volatility is a reflection of fear and uncertainty.
Price volatility and risk arise from many sources...rumors, political assassinations, earthquakes and so on. Shareholders with little confidence in their company tend to overreact to rumors and bad news. Consequently, the stock prices of companies with erratic earnings performance suffer more when unfortunate things happen. Stocks of companies with steady, predictable earnings can weather nearly any storm.
Obviously, there's less risk in holding stocks of financially stable companies. Consequently, I analyze the risk factors of stocks very carefully before buying.
The second key factor in picking stocks is to favor safe stocks.
Rule III:
Favor Stocks with Rising Prices. The hardest thing for most investors to do is buy a stock while its price is rising. Most of us have been taught to wait for a stock to go down before buying it. The idea of buying stock at a lower price makes a lot of sense, but is fallacious.
First of all, you'll miss a lot of good opportunities. Really good stocks usually don't look back once they have started moving upward. Witness the hundreds of stocks that have doubled and tripled over the last few years with nary a downturn.
Even more importantly, you never know where the bottom is when buying a stock whose price is falling. Remember when IBM went from 175 7/8 to 37 5/8. Who'd of believed it? I did because VectorVest did not reflect IBM as being undervalued or safe as it was going down. However, when things started turning around and IBM's price started rising again, we gave it a buy signal.
Buying stocks on the way down lessens your chances of winning. Most of us dream of buying a stock at its low point and riding it to the moon. It's a great dream, but the chances of doing so are virtually nil. The low points on good stocks don't last long. You have to be very lucky to bag a bottom.
Picking stocks with rising prices not only obviates the above problems, but offers several advantages. First, a stock that is rising in price is already doing what you want it to do. (You don't have to break a rising stock of a bad habit.)
Buying stocks with rising prices does not preclude the idea of buying them right after they hit bottom. Bottom Fishing is a great sport. You just have to know when the price trend has gone from down to up.
Finally, a stock that is hitting new highs has essentially no overhead resistance. There are no unhappy buyers waiting to get their money back. I especially like to buy stocks hitting their very first 52-WEEK high. These stocks have had plenty of time to consolidate, and are showing new signs of life.
It's fun to own stocks with rising prices. So pick stocks with rising prices.
Rule of Rules:
Pick Safe, Undervalued Stocks with Rising Prices. That's easy to say, but how does one find safe, undervalued stocks rising in price? Try following these steps:
1. Look at the financial section of your local paper, the Wall Street Journal, Investors Business Daily, Barrons, the internet or whatever. Find the list of stocks that have just hit new 52-WEEK highs. All of these stocks are definitely rising in price.
2. Rank all these stocks in ascending order of Price to Earnings ratio, i.e., P/E ratio. This may take some work, but low P/E ratio stocks of course, are undervalued.
3. Assess each stock for safety. Since the subject of safety is not touched upon in the papers, you'll have to turn to other sources. Take a look at Value Line, for example or Standard & Poor's Stock Guide.
4. Now put all the information together in a logical, quantitative, unemotional way. Pick the ones you think are the safest, most undervalued and rising in price the fastest.
Once you have prepared your list of stocks, check them out using VectorVest OnLine. VectorVest's stock analysis and graphics software analyzes over 8,000 stocks every day for Value, Safety and Timing. It unifies these factors into a comprehensive indicator called VST-Vector. Stocks with the highest VST-Vector ratings have the best combinations of Value, Safety and Timing.
There's no need to spend hours and hours doing what a computer can do. You can obtain a complete, rank analysis of any list of stocks with VectorVest in just a few minutes. Our records show that stocks with the highest VST-Vector ratings outperform the market over the long-term.
This comes as no surprise. Common sense and simple logic dictate that picking safe, undervalued stocks rising in price should result in above average performance.
