What makes a stock a good value?
A value investor believes that the market isn't always efficient and that it's possible to find companies trading for less than they are worth. However, that's easier said than done. If it were simple to find "bargain stocks," everyone would be doing it - instead of continuing to pour money into the "sheep" stocks that millions buy into.
Investing, is a quest for an edge. You can certainly invest in a bundle of companies, such as those that make up Standard & Poor's 500-stock index, and achieve market returns -- historically, about 10% a year, on average. But most of us would like to do better.
That's not easy. The efficient market hypothesis holds that the price of a stock reflects everything that could possibly be known about it right now, including profits anticipated in the future. So you can assume that, for most stocks, today's price is "correct" -- that is, investors are unlikely to be missing important information about a company.
Clearly, this is not what happens to most stocks on most days. Even Warren Buffett wrote in a letter to Berkshire Hathaway shareholders market was frequently efficient, but not always efficient.
There are two major areas of inefficiency in the stock universe: micro-cap stocks and value stocks. I am a fan of micro caps, as they offer the opportunity to make a bundle in a short time. However, they can also fall rapidly, so know when to get out before you get it.
Micro cap stocks also can provide many opportunities to make money on the same stock! Consider the example of Medbox (MDBX), which saw shares surge 3,000% - from roughly $4 to $215 in just 3 days! Clearly, a LOT of money could be made if you got in a $4 and got out at $215. You can probably do the math, but just to make sure you understand - a measly $4000 investment would be worth $215,000 just 3 days later.
Then the inevitable tumble occurred, and the stock slid down and sat there for awhile. This is another good time to buy, as the bottom was found. Now, the stock is back on its way up - so I'm recommending buying.
Value stocks, on the other hand, are both inefficient and relatively tame.
A value stock is one that is unloved. Its price is low compared with the underlying company's net worth or performance. In his classic book What Works on Wall Street, James O'Shaughnessy looked at data over 52 years and found that stocks chosen on the basis of value most often turned out to be winning investments.
And sometimes, the best bet is to find a micro cap that is also a value stock. By this I mean that the stock is cheap, there is tremendous upside potential, and the stock price is not adequately reflecting the future growth of the company.
Several stocks fall into this category, including Medbox and another stock I've mentioned in these columns, AVT (AVTC).
So what's the problem with AVT?
The company is on an unbelievable journey. Their revenues increase by around 50% each year for the past 4-5 years. Show me another company that achieves that kind of growth and sustains it year-after-year.
AVT is (like Medbox) in an exploding industry. The space is wide open and companies in it can continue to achieve mind-numbing revenue increases.
So what's the problem?
The fact is, AVT stock is just unknown, and lightly traded.
I think the stock is a bargain at today's prices, yet unlike Medbox, it won't surge to $215. However, it could reach $10 shortly, which would triple your investment.
In summary, there are bargains out there... some can rise fast (like Medbox) and others seem to have more of a slow growth curve (like AVTC). Either way, these stocks and others like them will far outperform just about any on the SP 500.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.