What is "Bargain Hunting?" - Value Investing Part 1 | Fundamental Analysis

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What is "Bargain Hunting?" - Value Investing Part 1

Stock investors are bargain hunting! That is the headline for a lot of news articles over the last few days. It does seem logical doesn't it? After all if stock prices have been cut by almost 40% since the peaks in 2007 there must be some bargains out there. Article authors are attributing the recent market rallies to the "fact" that this 40% discount must mean there are bargains just waiting for savvy investors to buy them. bargain

This is a great example of why the financial news is extremely unreliable. Writers must find a "cause" for each day's movement but those causes are not consistent over the long term and are usually nothing better than random guesses. However, financial reporters are driven by a primal need to find the reason why something happened so we will continue to see these kinds of headlines in the future.

Bargain hunting implies that a stock is worth less than it should be and is therefore undervalued. Being able to pick undervalued stocks or so called value-investing would be quite a talent but is there really such a thing as an undervalued stock? Because a stock's price is a combination of investor estimates for future growth/revenue/dividends/etc. it is logically only a matter of opinion as to whether that stock is undervalued. Will my estimate for future growth be better than any other informed investor? Probably not but this doesn't mean that there isn't any value in value investing.

S&P 500 Index ETF (Top) & iShares S&P 500 Value ETF (Bottom)
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I have found that value investing does help to avoid some volatility. That can be a good thing because account volatility is tough to take emotionally and leads many investors to make hasty decisions. If you are a longer term trader then using reasonable value measures to evaluate a stock before you add it to your portfolio is a great way to help smooth your returns and equity curve by avoiding that volatility.

There are as many value measures as there are value investors but some are more useful than others. In this article we will start the discussion behind a value measure or multiple you can use to screen stocks as that may be "overvalued" or

more volatile than stocks that are "undervalued" or likely to be less volatile from other possible picks.

As I mentioned there are many ways to apply a value measure to a stock but probably the most common is the P/E or Price/Earnings ratio. Dividing a stock's price by its earnings per share is a standard way to grab a snapshot of a stock's value. A very high P/E infers that the stock is overvalued and probably volatile. A lower P/E usually seems better but it doesn't account for growth.

In the next article we will talk about how to combine the P/E ratio with a stock's growth rate or expected growth rate to create the PEG ratio. It is one of the best ways to screen stocks easily and quickly because it summarizes so much information about a company's financial performance in an easy to understand snapshot.

- You can find out more about fundamental analysis and financial ratios like Return On Equity (ROE) here