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How to find value stocks

The best time to scoop up good deals is after a crash. But there are values to be found even now, when stock market indexes are relatively high.

May 01, 2011|Kathy M. Kristof | Personal Finance

For most investors, a market crash is a minor disaster. For value investors, who seek out shares in undervalued companies, it's hog heaven.

"The best time to practice value investing is when there is general panic," says Whitney Tilson, managing partner of Tilson Mutual Funds and organizer of the Value Investing Congress, a conference that will be held in Pasadena on Tuesday and Wednesday.

"There was never a better time for value investing than March of 2009," he said. "That's because people were willing to sell me businesses for a fraction of what they were really worth."

But there are values to be found even at a time such as now, when stock market indexes are relatively high. The trick is in knowing how to find them.

The conference is an opportunity to learn about value investing, but at a high price — ticket packages range from $2,795 to $4,395.

If you don't want to spend that kind of money, here are a few tips for identifying value stocks:

• Know your market: If you want to pick individual stocks, you'd be wise to stick to products and industries that you know well enough to evaluate.

Consider what sort of expertise you have and choose investments accordingly. This is likely to lead you to concentrate on a specific industry or even a niche within an industry. You might be an avid shopper, for example, so you could rattle off 20 ways that Wal-Mart is different from Kmart. A doctor might have very specific reasons to think that one drug company is better than the next. Stick to your strengths.

• Check relative prices: Once you've narrowed your investment search to a specific industry, you can find out the normal industry multiple, which is market shorthand to describe the relationship between a stock's current selling price and its earnings.

For example, a stock that sells for $20 and earns $2 a share annually has a multiple of 10. Another term used for this is P/E, which stands for price-to-earnings ratio.

Every industry has a normal multiple, and companies within each industry do too. Utility stocks, for instance, usually have a multiple of about 12, which is indicative of shares that tend to be relatively stable and slow growing. Tech stocks, on the other hand, sometimes have a multiple of 20 or more because they are fast growing but riskier.

A good reference for normal multiples is the Value Line Investment Survey — your local library probably has a copy.

If you determine that a stock is selling for considerably less than its normal multiple, it could possibly be a bargain.

• Do your research: If a company is selling for a price that's outside its normal multiple, you must find out why before you invest.

If the multiple is less than normal, the stock might be undervalued and therefore a potentially good buy. But a less-than-normal multiple might reflect lowered growth prospects, which would make the stock much less attractive.

Read everything you can about the company, including recent financial statements and analysts' reports.

• Look for barriers: Ideally, you want to buy shares in a company that is a leader in its field and is unlikely to face significant new competition because financial, technological or practical barriers would keep new competitors from jumping in.

• Bide your time: If you find a company you like but you think it's too expensive, wait for a sale, just like you would at the mall. Short-term events can cause the stock prices of good companies to fall even when the value of the business hasn't changed. That's when value investors swoop in.

business@latimes.com

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