The following question from JS is about stock picking:
I often see people talking about finding and purchasing undervalued stocks or stocks that are inexpensive given the performance of the companies they belong to.
I’m curious as to how one sets about finding such stocks. I understand the idea behind examining the fundamentals of a company and tracking their P/E ratios, but I’m curious as to how one finds the company to begin with. Does one suddenly say one day, “I like Coke. I’m going to check their fundamentals today to see if they’re undervalued, and if so, I’ll invest.” Or are there tools/web sites that list companies that are currently considered to be undervalued?
I’ve picked stocks with mixed success before (US stocks outperformed S&P index, Canadian stocks under performed TSX index) and I heavily used ValueLine Investment Survey’s screening tool (you local public library might have a subscription) as the first step in my research. From the ValueLine screen, I looked for “fallen angels”, companies that are in trouble for some reason that, in my opinion, can be fixed. This strategy led me to Altria Group, AIG, Home Depot, Anheuser-Busch etc., stocks that I still own and am reasonably happy with just holding. Other investors use similar screens: some use dividend yield signals of a small group of stocks (in Canada, it is fairly easy to come up with a short list), some use price-to-earnings, price-to-book ratios etc.
Whatever method you think will be successful (many methods mysteriously stop working as soon as they become popular), you should realize that even professional investors find it difficult to beat the underlying index. It is also time consuming to keep track of the news flow, read the annual reports and periodically check that your investment thesis is still solid. Despite all this effort, it is still possible that stock picking is akin to a chimp throwing darts and you run the risk of badly trailing a low-cost, diversified portfolio of index funds.
