How to Be a Stock Market Bargain Hunter
By Sean Hyman, Editor of Commodity Trend
I love bargains. Heck, my wife loves them too. She’s loves going to garage sales in affluent neighborhoods and picking up things that are way undervalued.
One day recently, she was on her way to a garage sale when she saw a “moving sale” sign. So she headed straight for that house, went inside and started negotiating.
You see, we’d just moved into a much larger house and needed more furniture. But neither she nor I like paying retail for those types of things when we can go to moving sales or garage sales and find expensive stuff for cheap!
The people holding this moving sale needed to move out fairly quickly, so they were willing to negotiate. If someone had cash, they were even more flexible. My wife looked through their furniture and then had me come over to take a look. We tallied it up, and we were easily staring at $20,000 worth of furniture, even at “used” prices. This was nice, custom stuff.
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However, we ended up buying so much stuff from them so quickly that they cut us some even deeper discounts to get it out the door. In the end, we ended up paying $4,000 for $20,000 worth of furniture.
You see, you can often find opportunities to get something of value for far less than it’s worth, if you do a little digging. And, you know, I’ve found this to be true in the stock market as well.
Banking on Bad News
The best time to find bargains is when investors are scared. Some great deals can be found when companies are hit by really bad news and investors go running for the hills.
One of the greatest recent examples of this was the BP oil spill of April 2010.
Before the whole saga began to unfold, BP had been hit by a slowing economy, which caused its stock to crash from around $80 to $35. It was slowly beginning to recover from $35 up to around $63 a share.
However, in the midst of that recovery, the spill happened. That sent BP’s stock price plummeting from the $60s to around $27 per share before it was all said and done. Check it out below.
The Ugly News That Created a Bargain
You can see at its worst, BP stock traded over 700 million shares within one week as investors were scrambling to dump the stock at all costs.
This is what I call a stock that has reached a point of maximum pessimism. That’s typically when the worst of the selling is behind the stock, because most everyone intending to sell already did so. In fact, they did this almost all at once.
Well, since then, BP has licked its wounds and built a sideways base from which to launch higher. You can see that BP has “rounded the corner” and will soon break its five-year downtrend line.
But yet, does anyone want BP to this day? Heck no! Investors hear BP and their minds jump straight to the oil spill.
Always Size Up the Fundamentals
BP is a bargain right now. Some stocks look like a bargain, but they are ultimately headed to zero. So how can I know that this isn’t one of those times? It’s simple. I look at the fundamentals. This is where you can see what a company is really made of and if it’s likely to make it or not.
With that said, let’s take a look at what BP looks like fundamentally.
BP has a P/E of 7.76 and its forward P/E looks about the same for next year. What’s the S&P 500 trading at? It’s trading at a P/E of 15.91 as of this writing. So BP is trading 50% cheaper relative to its earnings than the S&P 500 is right now.
BP has a dividend yield of 4.50%. Compare that to the S&P’s yield of 2.07%. BP has a dividend yield of over twice what the S&P 500 has.
However, some companies have high yield but can’t sustain the dividend payout. How do we know BP can? It’s because they have $15.18 billion of cash on their books … believe me; they’re good for it.
Additionally, BP is a $132 billion company that earned $36 billion last year. That’s a far cry from going under. It’s still a huge force to be reckoned with. I’m glad I don’t have to start up a company today and be their competitor.
And finally, BP is trading near its book value of $35.39 per share. As of this writing, BP trades around $41. That’s not far off from its liquidation value, which means the stock is being priced for its assets and not for its earnings power. That’s a mispricing by the market that won’t last forever.
Don’t Write Off the Beaten-Down Stocks
So when you see a huge company that’s taken a significant hit and investors are running for the hills, don’t write that company off. Instead, do what these investors refuse to do, which is to think rationally and ask yourself if this is still a viable company.
Look at its fundamentals and see if the company still is a force to be reckoned with or if it seems like they are headed to the dustbin. Then, if it is still has favorable fundamentals overall, wait until the stock gets past its point of maximum pessimism where investors sell en mass. You’ll know this because the weekly volume will spike up to at least double its average.
If both of these have happened, then you might consider investing in a company like that with some of your more speculative capital. In other words, this isn’t how you should choose every investment … but it is the way you can make some high probability, speculative investments on companies that could have some very large, outsized returns over time.
I think that’s where BP stands today. It’s likely a good long-term speculative investment from where it sits right now.
Remember the key things above and you can size up any future BPs that you may be looking at. You’ll be surprised what gems you may find that others simply don’t see.