Adding undervalued TSX stocks to your portfolio is a great way to boost your returns over time. There are some key factors you need to watch out for, though, so read on

High-quality “value stocks” are stocks that are reasonably priced, if not cheap, in relation to their sales, earnings or assets. Investors hold onto them because they expect that other investors will recognize their value and push up the share price.

When you look for undervalued TSX stocks, 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.

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Undervalued TSX stocks are great to find

Market pessimism can let you find some undervalued gems—stocks that drop along with the market as a whole yet still have sound fundamentals. But one of the sweetest and most profitable pleasures of successful investing is to buy high-quality “value stocks,” then hold on to them as their share price rises.

As mentioned, value stocks are typically stocks trading lower than their financial fundamentals suggest. They are perceived as undervalued, and have the potential to rise. Many new tech stocks, by the way, start out as growth stocks and transition into value stocks.

Use these ratios as a starting point to finding the best TSX value stocks

As more investors come to recognize the worth of these value stocks, they begin to rise. Well-informed investors who recognized the value while the stock lingered at a cheaper price begin to reap the benefits of their foresight.

When we look for value stocks to buy, we usually start by looking at a few basic ratios.  For example:

• Low price-to-earnings ratio—a sign of a cheap or undervalued investment.
• Low price-to-book-value ratio—another sign that the stock is cheap in relation to other stocks on the market.
• High dividend yield—the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.

Value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true worth. 

Here’s how to find undervalued TSX stocks for long-term gains

TSX value stocks are companies that are undervalued, based on a number of measures, on the Toronto Stock Exchange.

Some investors only feel safe buying stocks after prices have risen, which means that they often overlook TSX value stocks. Yet this is the opposite of the way you make most purchases (cars, clothing, etc.) Ordinarily, it’s better to buy when prices go down, not up. When buying stocks, you’ll find this same logic applies.

The first step to finding TSX value stocks is to visit the websites of the companies you are interested in investing in. Get on their mailing lists, and read their quarterly and annual reports. Ask your broker for research reports. Read the business news every day. You’ll be less liable to get caught off guard by price fluctuations and over time you’ll begin to spot the most undervalued stocks in a lineup simply through observation.

In addition to getting to know the companies you invest in, you should also get to know the industries that stocks operate in. Some industries are more volatile than others. Don’t invest in industries you’re not familiar with, and you’ll steer clear of many overvalued stocks.

Consider earnings, dividends and other factors in making decisions. They matter far more than short-term stock-price trends.

Stock prices rise and fall. But strong stocks tend to fall less and rise faster than poor stocks. And don’t overlook top dividend stocks—these companies like to ratchet their dividends upward. Even during market downturns, the last thing a well-established company is likely to do is lower its dividend. When times are good, strong companies will raise their dividends.

Undervalued TSX stocks may include spinoffs

When a spinoff begins trading, it stands to reason that investors will put a low price on it. After all, the spinoff hits the market with a large number of neutral, if not reluctant, stockholders who have limited expectations for it, and who are willing to sell when they get around to it.

One group of investors who might be willing to buy a new spinoff are value seekers. And on the whole, it pays to follow the lead of these seekers of undervalued stocks, and to hang on through months of sluggish trading while reluctant spinoff holders exercise their urge to sell.

Use our three-part Successful Investor approach to guide you in picking undervalued TSX stocks

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. 

Some investors who follow the Efficient Market Hypothesis (EMH) believe there is no reason to look for undervalued stocks to begin with because all stocks are appropriately priced. What are your opinions on this?

Do you prefer value stocks or growth stocks in your portfolio?