5 Ways to Tell the Winners from the Losers When Buying Stocks at the Bottom

February 14, 2009 by Marie Claire

Right now lots of stocks look cheap. But there's a big difference between cheap and value stocks.

If you want to find the perfect long-term investment when buying at the market bottom, be sure to follow David and Tom's five simple rules...

Rule #1 -- Look for a deep moat.

A deep moat makes it hard for competitors to assault a business and eat away at its margins.

Take the online junkyard I told you about earlier...

Because you have to have zoning and "use permits" to store and sell totaled vehicles, it's difficult for newcomers to break into the salvage business. Plus, the auto insurance industry is very fragmented with hundreds of area managers. Each area manager makes the decision about who will sell his or her totaled vehicles. That's why this company has spent over 25 years building solid relationships with these agents.

But the deepest part of their moat is their extensive database of sale prices for millions of salvaged vehicles from millions of auctions. This allows the company to tell insurance companies and buyers exactly what to expect from a sale based on the exact condition of the car. And that means more consistent prices, which makes this company the first choice for insurance companies looking to sell totaled vehicles.

Rule #2 -- Look for hidden value.

This online junkyard has a lot of hidden value that the market is not recognizing yet. For one thing, as cars become increasingly sophisticated with crumple zones, airbags, computers, sensors and more, they are more expensive to fix and that makes them more likely to be totaled in an accident.

But most of the hidden value in this company comes from opportunities that are just now taking shape...

For example, the company is taking their online auctions to the general public. All you have to do is drop off your car and they take care of the rest. As the company president put it, they combine "the convenience of CarMax with the transparency of eBay."
But that's not all...

The company is also partnering with auto dealers to help sell trade-ins. Dealers can now use the online auction system to easily and quickly move older models, nonrelated brands, and other nonstandard vehicles that they receive in trade-in but can't otherwise sell. This is a huge opportunity and one the company is only just starting to promote.
And that doesn't even count the company's overseas expansion...

Rule #3 -- Look for good management and ownership.

The CEO of this hot growth company is a good old boy worth billions. He loves to drink beer, grill burgers, and work on cars. But don't let his down home attitude fool you; he's one smart grease monkey.

He started out with a small junkyard and grew it into a billion dollar business, and he is still the largest shareholder today with 11% of the company.

But that's not all...

He knows his stock is a screaming bargain right now and he's got the cash to buy it. That's why he's backing up the truck and loading up. The company repurchased nearly 3 million shares in the last quarter of FY2008.

That boosts earnings per share and it's good news for shareholders who stand to benefit from the company's incredible growth potential.

Rule #4 -- Look for a bargain price tag

The stock has taken a beating lately as hedge funds and mutual funds dump shares to meet redemptions. Right now the stock is selling at a 50% discount to its 52 week high despite beating analysts' estimates by a penny per share in the most recent quarter! And that makes it the ideal candidate for savvy investors looking to snap up a great company at fire-sale prices.

Rule #5 - Average in to limit your downside risk.

Because hedge fund selling could continue for months, the best way to guarantee you'll get this stock at the lowest price is to "average in."

Rather than trying to time the market and catching this stock on the way back up, start dollar-cost averaging into this stock today. Don't buy all at once; add new money, even in small amounts, on a regular basis.

Then commit to holding the stock for the next 3 to 5 years. Remember, Sir John Templeton held his stocks for 4 years before cashing out at a substantial profit. And Warren Buffett is buying for the long term as well.

Both men built fortunes following this deceptively simple and time-proven strategy. And fortunes will be made again as the U.S. economy recovers in the months and years to come.

In the words of Warren Buffett,

"This country is going to be living better 10 years from now than it is now. It will be living better 20 years from now than 10 years from now... We've got all the ingredients for a sensational future."

But you also may not realize that any stock market returns that you may achieve now will be achieved in a slowing economy, so where will that lead you? Buying for returns doesn’t serve a purpose unless what you’re buying will produce growth. Put it simply, are you buying because what you are buying is going to grow?

If you don’t know, you are just betting that this is right point in time. But this is not to say we will never see light again, either. Companies are in business to do business. As time passes, they will become more motivated to increase their profits and to make things happen, like making more loans to homeowners to bring profits in the door.

While you may be tempted to see this as the right time to get into the stock market, you also find is hard to justify an investment if the economy continues to slow down. Only the very bold will see this as a move to buy, and buy meagerly. The rest of us should question whether buying now is really worth the risk versus waiting for a safer entry point where we have more certainty with the economy, as well as seeing market volatility recede. We can still have a profitable portfolio for our future and not have to time it perfectly. While waiting for your invested money bear its fruits you need to hone your personal finance management skills to weather the storm.

(Personal Finance Management Guide by Marie Claire Cooper. It's all about good reading and smart information.) http://personal-finance-management.blogspot.com/

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