Find the best cheap stocks to invest in today by watching out for factors signaling danger rather than bargains.

Top-quality stocks tend to lose less of their value in market setbacks. They also tend to bounce back nicely when conditions improve. These are the kinds of stocks we continue to recommend in our newsletters and other services.

To build a portfolio of those stocks—and to show the best long-term results, Pat McKeough still thinks you should stick with his three-part program:

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Meantime, investors who “bargain shop” for stocks explain that they are simply looking to buy stocks like a smart consumer would buy a car. But they overlook one key difference. Car prices do vary, and some buyers do pay less than others, because they have better bargaining skills and more time to spend shopping around.

However, the stock market is more efficient than the car market, as an economist would put it. You can’t negotiate a favourable price for a stock. To get a lower price, you have to wait for the stock’s price to come down.

However, there are elements to consider when looking for the best cheap stocks to invest in today—that is to say, not every stock that looks like a bargain is really a bargain for investors.

The Profits from Hidden Value Learn everything you need to know in 7 Pro Secrets to Value Investing for a FREE special report for you. Canadian Value Stocks: How to Spot Undervalued Stocks PLUS! Our Top 4 Value Stocks  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

Dig deep for real value among the best cheap stocks to invest in today

It pays for Successful Investors to take an optimistic view of the best cheap stocks when prices appear low—for instance, when stock prices are in the middle or low end of their long-term range, based on p/e ratios.

However, it’s key that you dig deep to determine if a “cheap” stock’s price just reflects today’s wide economic and market volatility or does it really reflect its own hidden problems.

Suppose you decide you will only consider buying stocks with a per-share price-to-earnings ratio of 10.0 or less. That way, you hope to get more earnings for each dollar you invest. But the “e” or earnings in the p/e only covers earnings, or an earnings estimate, for a single year. The year your stock’s low p/e looks attractive may coincide with a peak in the company’s earnings, for any number of reasons.

One key reason is that many disasters-in-waiting go through a low-p/e period prior to their eventual collapse. During this low-p/e period, people close to or involved with the company recognize that it has serious problems. They sell their own holdings and they tell their friends and relations to do the same.

Another common problem is that the company is cyclical and is at the top of its business cycle—and its earnings are at a peak. (It’s easy to overlook the fact that tech stocks tend to be cyclical. Their growth can mask the typical peaks-and-valleys of a business cycle.)

In contrast, specific reasons why a company’s profit may slump for one or more years include the expiration of a patent, new competitors, a rise in costs, adverse legal or regulatory changes, or investigations for illegal activity.

As the saying goes, a low p/e may signal danger rather than a bargain. Note, however, that staying out of high-p/e stocks can also hurt your results.

Use these four financial ratios as a starting point to find the best cheap stocks to invest in today

When you’re looking for undervalued stock picks, as a first step it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele.

High-quality undervalued stock picks like these are rare and hard to find, even when the markets are down. But when you know what to look for, you can discover them. These are four of the financial ratios we use as a first step in spotting undervalued stock picks:

• Price-earnings ratios
• Price-to-book-value ratios
• Debt to equity ratios
• Price-cash flow ratios

The best cheap stocks to invest in today will typically be in the middle of the value spectrum

To get value from any type of investment measure, you need to look at them in the context of everything else that’s going on, in the market and in individual stocks.

Most types of investment measures fall on a spectrum that ranges from suspiciously cheap to extraordinarily expensive.

So, it’s a mistake to focus—for instance—on stocks in the “suspiciously cheap” end of the p/e spectrum. It’s also a mistake to reject stocks out of hand, just because their relatively high p/e’s and other clues make them seem too expensive.

Most of the time investors will find their best opportunities in the middle of the spectrum, far from the extremes of cheap and expensive.

What factors do you look at to determine if a stock is cheap for the wrong reasons?