1. Money
You can opt-out at any time. Please refer to our privacy policy for contact information.

Buying on Bad News - Acquiring Undervalued Stock

Turning Bad News Into a Lucrative Opportunity for Your Portfolio

By

Even the best companies, industries, and sectors fall out of favor from time to time. A fully-informed investor, with a pocket full of cash and a firm understanding of the situation, can calmly stride into a turbulent market and buy up shares of these underdogs at a fraction of their intrinsic value. How do you know which companies are permanent losers and which are undervalued gems? Use these tests of quality to determine if you should invest your money or keep it stashed in cash.

Is the problem temporary or long-term?

You must be careful not to simply invest in a company because everyone else is running from it; sometimes there is reason to run! Even after the share prices of companies such as Lucent and United Airlines had been cut by seventy-five percent, they still did not constitute a good investment. There are many companies that aren't worth buying at any price. Trash is trash, regardless of how much you pay for it.

In some cases, problems arise that are the result of one-time mistakes on the part of management. During the Savings and Loan crisis, for example, bank stocks were beaten down to almost comical levels. An investor who mentioned he was purchasing shares of these institutions was immediately scorned, mocked, and considered crazy by even close friends. At the same time, firmly entrenched companies such as Wells Fargo (which boasted a solid balance sheet, established reputation, top-notch management, and steady customer base), were hit just as hard as banks of lesser quality. Years later, those that had exercised courage and relied on their analytical judgment by purchasing shares in such banks found their portfolios much fatter. Remember the words of a very wise man; "you are neither right nor wrong because the crowd agrees with you; you are right because your analysis says so."

Is the business an excellent business with a suitable market capitalization?

As always, you should be interested in non-asset intensive businesses with high returns on equity, little or no debt, operating in non-commodity type industries without fixed cost structures. You should also attempt to look for under valuation in larger rather than smaller companies. In the event of a retail recovery, for example, Wal-Mart is more likely to recover sooner than a small specialty retailer such as Tuesday Morning. The owner of smaller issues may find himself waiting considerably longer for his shares to realize their full value in the market.

©2014 About.com. All rights reserved.