Over the last few years, bullish momentum has dominated the Street. Equity markets have chugged higher, breaking record after record. And while 2015 has been quite tame compared to years prior, the fact is that stocks are still trading near or at all-time highs.
This type of market environment has made it difficult for those investors looking for new opportunities. The process of uncovering financially solid but undervalued companies has become even more difficult. Today, I’d like to go back to basics, highlighting the key steps needed to accomplish this increasingly difficult task.
Screening for Undervalued Companies
Before even starting to rip apart financials, the very first step every investor needs to do is to clearly define their investment objective. For example, some of the questions you may ask yourself are:
- Do I value lucrative yields more than consistent and stable income streams?
- Am I comfortable with certain risks, such as foreign currency exposure?
- Will I be able to actively monitor certain positions, or am I more comfortable with investments I don’t need to babysit?
These types of questions tell you a lot about your unique risk/return profile, meaning what you are willing to risk to get more bang for your buck. Other factors such as age, retirement needs, and current financial standing should also be weighed in your investment profile.
After defining your objective, the next step is to clearly write it out for yourself. While it may seem trivial, this clear-cut reminder of what you want to do with your money is essential, especially when our behavior can sometimes become erratic during periods of market volatility—or even during strong bull runs—where fundamentals tend to get kicked aside.
For us long-term investors, the next steps sometimes seem a bit daunting. With so many stocks to choose from, it is important to carefully select your hard-line requirements. For example, you could screen the equity universe for only those companies that have consistently increased dividends for more than 25 years. Another criteria could be market capitalization, which filters out riskier small and micro cap firms. These screening criteria should be strict and inherently unique to your objective and risk/return profile.
After narrowing down the list, we recommend investors take a bottom-up approach to analyze potential investments. Simply put, this strategy hones in on the core of value investing – company specifics and fundamentals. This is where investors need to roll up their sleeves and get their hands dirty. Carefully evaluating company filings (and not just the most recent one) is a must.
After studying the numbers, and fully understanding them, investors should then educate themselves on the company’s business. At the end of your research, you should be able to thoroughly answer the question: how does this company make money? The next steps are sometimes a bit vague, but nonetheless are important. Factors like industry trends, foreign currency exposure, and broader macroeconomic conditions should also be weighed in each investment decision.
Investing Requires Work
The steps outlined above really only scratch the surface of what is involved in finding financially sound, undervalued companies. Many investors can get overwhelmed with such a seemingly daunting task, but what is important to remember is that in order to get an investment to work for you, you need to put in the up-front work.
Here at Dividend.com, our mission is to help guide and educate readers to make better financial decisions. Be sure to utilize our tools and resources, such as the Screener or our Best Dividend Stocks List, to help evaluate potential investments.
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