Investing in Discounted Stocks

Today’s stock market is largely characterized by uncertainty. The VIX, the options trader’s measure of market volatility, is high. Investors and traders are jumping in and out of the market, afraid of missing a rally and concerned about losing with a big market correction due to a debt default. What is a long term investor to do? One prescription for the current mess may well be investing in discounted stocks. The basis of long term investing is that a well managed company with good products, and good market penetration will prosper over time. The basis of today’s value investing and value investing in general is to find stocks that are underpriced according the value of their assets and their forward looking income stream. Today’s tech giants such as Oracle, Microsoft, Hewlett Packard, Intel, and IBM are all underpriced compared to the tech stocks in general when their forward looking income is considered. These companies have cash and are the kings of a high cost of entry business, producing quality products in quantity in high technology. Investing in discounted stocks is not always investing in forgotten stocks. There are times like now when investing in discounted stocks is investing in the household names of high tech.

Investing in discounted stocks such as the high tech giants listed above involves finding stocks with a margin of safety, the concept that has guided value investors for more than seventy years. Often these are dividend stocks as the companies in question have little debt and lots of cash. Many times these companies will actively buy back stock in an effort to boost stock price to the benefit of their stock holders. Companies with substantial physical holdings also qualify when investing in discounted stocks as the market often does not appreciate the value of these assets. Investing in discounted stocks is not just investing in companies with cash as many companies with cash and paying dividends are fairly valued and not likely to appreciate rapidly. The point of buying a discounted stock is not only that there is the margin of safety supporting its value but that sooner or later the market prices in the value of currently ignored holdings. The market eventually recognizes that the company is making more money effectively bids the price up.

Which are the discounted stocks? Those listed above seem to qualify as they are priced ten to thirty percent below what the market is paying for other stocks based upon income stream and asset value. Looking for low price to earnings ratios is a time tool for investing in discounted stocks. The investor pulls up a screen of low PE ratio stocks in a given market sector or in a large, medium, or small cap range. Then the investor investigates each stock in succession looking for cash and absence of debt, physical assets, ownership of subsidiary companies, and other measures of asset value. Investing in growing companies is not just limited to startup companies and penny stocks. We are not suggesting that the investor go out and buy any of the stocks listed above or than he or she ignore them. Rather it is useful when investing in discounted stocks to develop a strategy that is successful in picking new winners in the stock market.

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