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.