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 the turbulent market and buy up shares of these underdogs at a fraction of their value.  How do you know which companies are permanent losers and which are undervalued?  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 in half, 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 one-time mistakes or not entirely management's fault.  During the Savings and Loan crises over a decade ago, bank stocks were beaten down to almost laughable levels.  Any investor who mentioned they were purchasing shares of these institutions were immediately blacklisted, mocked, and considered crazy by even their closest 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 found their portfolios much fatter.  Remember, 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 undervaluation in larger rather than smaller companies.  In the event of a retail recovery, for instance, Wal-Mart is more likely to recover more quickly 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.

Does management have an excellent track record?
The best indicator of future performance is past results.  Great managements tend to produce great results for everyone involved, including the shareholders, employees, directors, executives, and customers.  If a company has run into huge problems year after year due under the direction of current management, it is vain to hope for richer rewards in the future.  You and your pocketbook would be better off ignoring the empty promises of executives who are only interested in keeping their jobs.

The quality of management question is perhaps one of the most important ones an investor must ask him or herself.  Coca-Cola is an excellent example.  A stellar company for generations, it wasn't until Roberto Goizueta became CEO the business became a truly global powerhouse, throwing off cash to its stockholders faster than they could gulp it down.

Are you financially able to wait out the storm?
After you've determined that the problem is temporary, management has an excellent track record, and the business has excellent characteristics, there is still one question remaining before you take out your checkbook and purchase shares.  Are you financially able to wait out the company's troubles?  What are the odds that you will be forced to sell your stock to meet another financial obligation?

If there is even the slightest chance of this occurring, don't even think about buying the stock.  "But it's a wonderful investment opportunity!" you may argue.  Yes, it may turn out to be one of the best investments of your lifetime.  However, if you don't have the luxury of waiting for the company's intrinsic value to be reflected in the share price, you are gambling.  As investors, we know that a good company will eventually be recognized by the market - we don't know when.  The moment you fail to make that distinction, you become a speculator.  In the short run, anything can happen.  What's to stop an undervalued stock to drop significantly in price and become even more undervalued?  Nothing.  You must have the time horizon to wait out the inevitable result of wise investing, regardless of it turns out to be a week, month, or several years.