How To Invest In Undervalued Stocks

What About Global Markets?

With markets in Europe and Japan seeing much of the same fate as the Unites States, global diversification almost seems to be a forgotten concept these days. For those investors who have been gathering cash and are now looking to enter the market again, history shows that a strategically diversified portfolio will outperform money market or bond investments over the long term.

It often helps to remind ourselves that, while some areas of the market may not be performing well in this downturn, other areas or regions may be offering decent returns. The idea behind diversification is to protect a portfolio from poor performance in one area by providing beeter performance in another.

Buying Undervalued Stocks

Since no one has a crystal ball to predict which regions will outperform, analyzing certain metrics, like price-to-book value, helps to uncover which stocks or sectors that are likely to perform well going forward because they are currently undervalued.

Price-to-book (P/B) is a popular ratio that indicates how much investors are willing to pay for a company’s assets. In general, the higher the ratio, the more expensive a stock is considered to be.

Where Are The Bargains?

The chart below (Courtesy RBC) captures the average P/B ratio for stocks in a number of different countries, which points to whether each market is over-priced or under-priced. The red line shows the mean, or average P/B value. Any circle above that line is considered an expensive market; anything below is considered to be attractively priced.

Stock markets in several countries, including the U.S., are now trading at below average P/B valuations. By contrast, Asia (ex Japan), China, Canada and Brazil are considered expensive relative to their historical mean valuations.

Charts such as these may help you understand why some investors are now overweight in equity exposure, many with a bias towards U.S. and global markets. It seems that the short term volatility in the markets has shifted investor focus off of valuations and into irrational fear. However, we know from historical statistics that not over-paying for investments is a key factor in achieving long-term success - which means it may be a great time to put some cash to work for the long term.

Comments

[Jim Hawthorne:]

Tyler, what part of "Bear Market" don't you understand?
June 30, 1988 to June 30, 2008 is a rather distorted time horizon, to say the least.
As an old greybeard who has lived through a couple of bear markets, "valuation" can be a fleeting and cruel siren. (after all, a deck chair at $1.25 on the Titanic might be perceived as a real bargain!)
Become a nimble and flexible trader, son; adapt to the real market conditions and stop locking yourself into a model just because it worked well in the past.
Last century the DOW averaged about 5.25% per year gain... at that rate, we should be up around 22,000+ today. There are times when "buy and hold" can work. Today is not the time.
With god knows how many baby boomers about to start living off their 401K's (or what's left of them), thereby exerting great selling pressure on the market, combined with tremendous global economic realignment, we are about to enter a radically different trading world.
Be nimble, and avoid the temptation to catch those "bargain" falling knives!

2008 Aug 04 12:50 AM