Spot the most undervalued stocks in three steps and by using these nine financial, safety and growth factors.

Some investors only feel safe buying stocks after prices have risen. 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. This rule applies to the most undervalued stocks on the market, just as it does to most stocks.

When investing, you’ll rarely if ever sell near the top, nor buy back near the bottom. If you could do that with any consistency, you’d “make all the money in the world”, as the saying goes. And no one ever does that.

Instead, the best way to identify the most undervalued stocks on the market—and make long-term investment profits— is to follow these basic steps and financial factors:

Step 1: The first step is to visit the websites of the companies you invest in regularly. 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 be caught off guard by price fluctuations and over time you’ll begin to spot the most undervalued stocks in a lineup simply through observation.

Based on this data, analyse these financial factors:

• 5 to 10 year history of profit. Companies that make money regularly are safer than chronic or even occasional money losers.
• 5 to 10 years of dividends. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.
• Manageable debt. When bad times hit, debt-heavy companies go broke first.

Step 2: 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. Knowing market sector share price fluctuations can alleviate anxiety and build confidence in your investments. Don’t invest in industries you’re not familiar with, and you’ll steer clear of many overvalued stocks.

Based on this data, identify these safety factors:

• Industry prominence if not dominance. Major companies can influence legislation, industry trends and other business factors to suit themselves. Minor firms, on the other hand, don’t have that power.
• Geographical diversification. Canada-wide is good, multinational better. There’s extra risk in firms confined to one geographical area.
• Freedom to serve (all) shareholders. High-quality value stock picks must be free of excess regulation, free of dependence on a single customer, and free from self-dealing insiders or parent companies.

Step 3: 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 dividend stocks like to ratchet their dividends upward. Even during market downturns, the last thing a well-established company is going to do is lower their dividend yield. When times are good, strong companies will raise their dividend yield.

Based on this data, identify these growth factors:

• Freedom from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. That’s why you need to diversify. Invest in utility, finance and consumer stocks, along with resources and manufacturers.
• Ability to profit from secular trends: These trends outlast ordinary business booms and busts, because they reflect ongoing social change. Free trade and rising environmentalism are just two examples of secular trends.
• Ownership of strong brand names and an impeccable reputation. Customers keep coming back to these businesses, and will try their new products.

Finally, when you find what you feel are the most undervalued stocks, consider investing at least some of your funds by practicing “dollar cost averaging.” Invest the same dollar amount on a regular basis. That way you’ll buy more shares when prices are low, and fewer when they’re high.

In fact, if you invest a fixed sum at regular intervals throughout your working years, perhaps increasing that sum from time to time as your income rises, you can largely forget about market trends. If you factor in dividend payments, dollar cost averaging could make a huge difference to your long term profits.

Are you new to value stock investing? Have you changed your approach over the years? Let us know what you think in the comments section.