Two Ways To Find An Undervalued Stock

The word “undervalued” is one of the most commonly used, yet often undefined, words in investment discussions. The general principle of searching for undervalued stocks is straightforward enough: People that buy undervalued stocks want to find a company that is worth more than the current price of the stock indicates. But the tactics for making this identification differ among the thousands of men and women that dedicate sizable chunks of their life energy to this pursuit.

Charlie Munger said that we all have an obligation to destroy at least one deeply held conviction per year. When I first started studying large-cap stocks, I believed that a stock was undervalued if it traded at a P/E ratio below its historical range. I knew it didn’t apply to fast growing or small firms, but I figured that if Smucker usually trades at 23x earnings and an opportunity arises to buy at 18x earnings, there must be a high probability that the stock is undervalued.

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The Japan ETF (EWJ) vs. Aflac Stock

Since 2009, the United States stock market has outperformed the stock markets of most other countries, and you have not heard as much investment commentary touting the value of international diversification. I think much of the debate is silly, as the kinds of companies that make up the S&P 500 generate a substantial chunk of their profit outside the United States. Coca-Cola may be considered the most Americana of companies, but it makes 80% of its profits outside the United States.

You want 3% of your portfolio in Mexican stocks? Well, Coca-Cola makes 3% of profits in Mexico. Problem solved.

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The Deception Of Book Value

When Benjamin Graham covered stocks, he used book value as his primary determinant in calculating value. He was well aware that when a company in distress goes on to survive, the share price of the stock can easily double, triple, or quadruple once investor certainty surrounds the pending survival. And if the company did not survive intact, the liquidated parts could sometimes still give you a positive return.

Although book value can still be a useful measurement tool in certain situation for bank and insurance companies, the usefulness of the metric has become outdated for three reasons:

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The Performance of Trust Funds

The average trust fund in the United States has underperformed the S&P 500 by 2.3 percentage points annually during 2004-2014, according to a study released by the U.S. Trust. That may not be quite the indictment you think it is, as the specifics of underperformance were not examined. A lot of times, when you’re dealing with seven-figure portfolios, you start to enter that wealth preservation mode and U.S. Treasuries start to become an important of the picture.

If 25% to 50% of the principal is invested in things paying 3%, it makes sense that even shrewd stock pickers would have trouble keeping pace with a basic index fund. But it is also possible that the trust management was a result of mediocre investment selection that could have been fueled by poor incentives in the trust management field.

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Jack Lew’s $10 Treasury Mistake with Alexander Hamilton

If you ever study alternative dispute resolution methods, the central principle that you will learn is that not everything in life must be a zero sum game. A great mediator is different from a good mediator if he is able to find ways to expand the pie rather than distribute existing resources in the most tolerable way to concerned parties.

Usually, these type of tactics are most useful when trying to sort out disputes between struggling but still profitable businesses and the creditors that are receiving less than they are fully owed. Imagine if you operate a restaurant in 2009 that makes $10,000 per month against $11,000 in operating costs with a $3,500 monthly rent being a big chunk of those operating costs. If you have a zero-sum mindset and represent the landlord, you are going to be focused on evicting the restauranteur and finding someone else as a tenant.

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