Adding the best value-investing stock picks to your portfolio starts with looking for hidden assets and overall investment quality

When you look for value-investing stock picks, 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 value stocks like these are difficult to find. But when you know what stocks to look for, you can discover them.

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Hidden assets are the key to spotting value-investing stock picks that are ripe for a takeover

An important part of our investment approach involves looking for companies with what we call “hidden value”—hidden or widely overlooked assets.

By hidden value, we mean valuable assets that are not getting the attention they deserve from investors. When a company’s assets are wholly or partially ignored or hidden, the stock trades for less than it’s really worth, so you get to buy at a bargain price.

Companies that launch takeovers also tend to look for hidden assets. That’s why so many of the value investing stock picks we recommend get taken over. Of course, hidden assets are no guarantee of a takeover, but they cut long-term risk, and make a takeover a lot more likely.

If a stock with hidden assets gets cheap enough, it attracts buying by value-oriented investors. Its low price may also trigger a takeover that otherwise might never have happened.

Sometimes, of course, hidden assets stay hidden for a lengthy period. But as long as a stock has more obvious appeal, such as long-term growth prospects, a reasonable per-share price-to-earnings ratio or an attractive dividend yield, you have what we call the best of all possible investment worlds: a heads-you-win-tails-you-break-even situation.

If it works out well, it can be extraordinarily profitable; if it works out poorly, you really shouldn’t lose that much.

Investment quality is the key to finding value investing stock picks at a bargain

The best investment plans or systems revolve around choosing high-quality investments and diversifying your holdings.

Remember to spread your portfolio out across most if not all of the five main economic sectors: Resources; Manufacturing; Finance; Utilities; and Consumer. That way, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or changes in investor fashion.

By diversifying across the sectors, you also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average. These stocks come along every year. By nature, their appearance is unpredictable; if you could routinely spot them ahead of time, you’d quickly acquire a large proportion of all the money in the world, but nobody ever does that.

Our three-pronged Successful Investor approach also encourages investors to not just spread investment money out across most if not all of the five economic sectors as mentioned, but to also invest mainly in well-established companies, and focus on companies that are outside of the broker/media limelight.

Bonus tip: A corporate spinoff may lead to good value investing stock picks

From time to time, companies set up one or more of their divisions or subsidiaries as an independent firm, then hand out shares in that company to their own investors as a special dividend, or “spinoff.”

A number of studies have shown that after an initial adjustment period of a few months, spin-offs tend to outperform groups of comparable stocks for several years. For that matter, the parent companies also tend to outperform comparable firms for several years after a spin-off. That above-average performance makes sense for a couple of reasons.

First, company managers naturally prefer to acquire or expand their assets, not get rid of them. Getting rid of assets reduces a company’s total potential profit, which reduces the funds it has available to pay its managers. The management of a parent company will only hand out a subsidiary to its own investors if it’s fairly confident that the subsidiary, and the parent, will be better off after the spin-off than before.

Second, corporate spinoffs involve a lot of work and legal fees. The parent will only spin off the unwanted subsidiary if it can’t sell the stock for what it feels it’s worth. That’s why companies only have an incentive to do spin-offs under two sets of favourable conditions: When they feel it isn’t a good time to sell (which often means it’s a good time to buy); or, when they feel the assets they plan to spin off will be worth substantially more in the future, possibly within a few years.

Oddly enough, many investors react to spin-offs as a nuisance, because they leave you with a tiny holding in a stock you didn’t choose and know little about. As a result, these investors may dump any spinoffs they receive as soon as they get around to it. They’d be better off to buy more of any spinoff they receive, because spinoffs seem to come with the odds set in the investors favour.

Corporate spinoffs and their parents sometimes run into unforeseeable woes. However, human nature makes it a good bet that both the parent and spinoff will prosper.

Do you agree or disagree that controversy can unearth investment value? Why?

What do you think of the potential for value investing in new companies within established industries?