Investing can have an incredible upside if you know what you’re doing.
A true investment is something that increases in value over time. So, it’s crucial to buy stocks that will increase in value.
While a return on an investment in stocks is never guaranteed, there are some actions you can take as an investor to increase the chances of choosing stocks that will increase in value and make you great returns.
One of these actions is to only buy stocks when they’re on sale.
Buying stocks “on sale” helps take the risk out of investing and makes it easier to get great companies at a price that will allow for great returns.
I’ll walk you through what it means for a stock to be “on-sale”, how to find stocks on sale, and when it’s a good time to buy stocks on sale.
Why Stocks on Sale are Important to Invest In
You wouldn’t buy a $30 t-shirt at the store if you could get the same t-shirt for $15 at the next store. Similarly, you shouldn’t buy a company’s stock for $30, if you can get it for $15.
Now, like anything of really great value, great stocks don’t go on sale that often, but when they do, they provide the opportunity to get companies with great intrinsic value for half off, or more.
Why does this matter?
The theory of efficient markets suggests the market eventually prices companies at their true value. So, what are underpriced stocks today that will eventually be accurately priced according to their value?
If you can buy a company’s stock at 50% of its value, you can double your money when the stock price adjusts. You can buy low and sell high. This, of course, is the ultimate goal of investing.
There is always some risk to investing but you can minimize that risk and maximize the potential reward if you follow this strategy.
The sale price gives you a safety net, so that even if the company were to experience hardship, or your calculations were a bit off, you could still make a positive return on your investment.
This is how we follow rule #1 of investing: “Don’t Lose Money”
How To Find Undervalued Stocks
If this strategy all but guarantees you won’t lose money, why doesn’t everyone follow it? Well, finding undervalued stocks requires a lot of patience and a bit of work.
Plus, you can’t simply scan the entire market at any given moment and tell which stocks are on sale and which aren’t.
You need to focus on five to ten wonderful companies and check those consistently—we call this list of 5-10 companies your watchlist. I’ll walk you through how to identify undervalued stocks, but first, you need to learn how to build your watchlist.
Research the Companies Fully
The first step in building your watchlist is to consider what companies you think you might want to invest in. A good place to start is with companies you love.
If you are passionate about a company’s mission, product, or service, you are going to enjoy learning more about them, which you will need to do to decide whether or not you are going to invest in the company.
It’s not a good idea to invest in something you don’t understand, even if or especially if it’s getting a lot of attention from other investors.
If you have a good idea of what a company does, any changes in its operations or financials will make more sense to you and help you make smart buying and selling decisions in the future.
Once you have a short list of companies you love, it’s time to research them fully.
You’ll need to learn about their management, how they make money, what makes them unique and separates them from the competition, and if they’re headed in the right direction financially.
If you’re looking for more help building your watchlist, check out this guide on investing in the stock market.
Identify The Stock’s Intrinsic Value
Part of researching the companies you want to invest in is determining their intrinsic value.
The intrinsic value is what the company is actually worth, which is determined by the quality of its operations, the health of its finances, the ability of its management, and the stiffness of its competition.
Identifying a company’s intrinsic value will help you as an investor know whether or not buying its stock is a good investment—will it give you a return on your money.
Price vs. Value
Value and price are not always the same thing. Most of the time they aren’t. Price is what you pay while value is what you get.
This is the foundation of value investing. If you can find stocks on sale or undervalued, you can get them at a price far less than they are worth and expect a great return. The same is true of the opposite.
If you pay a price for a stock that is far above what it is actually worth, you will lose money on your investment.
Determine The Margin Of Safety Price
Once you have determined a company’s intrinsic value, you can determine the margin of safety price, or the sticker price that signals the stock is on sale.
We’re not looking for just any sale sticker, though. We’re looking for a 50% off sticker. Stocks with this sticker are stocks on sale.
To find this price, take the intrinsic value price you determined earlier and cut it in half. The number you get is your margin of safety price.
Or, use my margin of safety price calculator. You can easily plug in all the relevant numbers to reveal the right price to buy, that is, the price at which you could safely buy the company to make a 15% return over a period of 10 years.
Now, knowing the margin of safety price is only half the battle. You then have to wait for that price to occur before you buy. This will require not only patience but also resolve to resist emotions or impulses that could sway you to buy too soon.
But, if you’re willing to wait, the opportunity will present itself.
Know the Difference: Event vs. Downfall
Now that you have your watchlist and you know everything you need to know about the companies on it, you wait for those companies to reach or fall below their margin of safety price.
As I talked about earlier, you’ll want to check in on these companies consistently or set alerts so you don’t miss your opportunity to buy the stocks on sale.
A company’s stock can go on sale for many reasons, some of which should be a red flag to you as a potential investor. It’s important to be able to decipher between the two overarching causes of an underpriced stock in order to make smart investing decisions.
Is this sale a temporary drop because of a Rule #1 event or is it because of a downfall of the company itself that they can’t recover from?
What is a Rule #1 Event
A “Rule #1 Event” is when something happens that makes the price of a good company drop far below its real value.
Rule #1 events could affect solely the company, the industry, or the market as a whole. Examples of Rule #1 events include natural disasters, recessions, supply shortages, or, most recently, the Covid-19 pandemic, among many others.
Events such as these provide the perfect opportunity to buy because they are only temporary hiccups that great businesses can bounce back from.
What is a Downfall
Stocks can also drop in price due to a decrease in value. This doesn’t mean the stock is on sale, though. If the value of a company decreases, so does its sale price.
To judge whether the company is undergoing a Rule #1 event or a downfall, you’ll have to ask a few important questions.
Is the business fiscally sound? Is the CEO honest? What triggered the price drop? Is it the kind of problem that the company or industry has recovered from in the past?
Consider all of these questions to feel confident that the company can recover from the price drop before you buy.
Be Confident Your Value Stock Will Recover
Rule #1 events affect a company without permanently destroying it. The price may drop but the long-term value of the company should remain the same. Rule #1 investors know that the company’s price will bounce back in time, but most investors don’t have the patience to wait.
When everyone else is selling out of fear, you can get an incredible discount on valuable stocks, and when you know enough about your company and the event that is occurring, you can be confident the stock will recover within 1-3 years.
Rule #1 investing doesn’t mean you won’t experience volatility or a dip in the stock price from time to time, but it does mean you will know how to profit from it when it occurs. So, be prepared and be patient.
Investing in this way is a long-term strategy. Remember, the market will eventually correct the price of a company to its true value. There are a few ways you can feel even more confident that the stocks you buy during a Rule #1 event will recover.
Look Back at the Company’s Past
Consider how the company has handled difficult times or circumstances in the past. When the company has undergone hardships or been through Rule #1 events previously, how has it responded and recovered?
If it has already come out the other side of hard times or continued to perform well even amid difficult events, it knows what it takes and is likely to do it again.
Consider their Competitive Advantage
Another way you can increase your confidence is to consider the company’s advantages over the competition.
If this is an event that affects the entire industry, does the company you want to invest in have unique traits or advantages that will help it outperform competitors and recover more quickly?
Patiently Wait for Your Money to Double
If you have thoroughly researched the companies on your watchlist, determined the margin of safety price you need to buy them at, and you encounter a Rule #1 event that sets their stocks on sale, it’s time to buy!
Then, you can sit back and wait patiently for your money to double, fully expecting that it will because you know you got a great deal on a company of great value.
Remember: Rule #1 investing is investing for the long term.
Practice Finding Stocks on Sale Today
The stock market is constantly moving, so there’s no sure bet that stocks on sale today will be on sale tomorrow, or that stocks you want won’t go on sale soon. You have to do your own market research and do it often to find stocks on sale and to be ready when you do.
It’s a good idea to practice finding stocks on sale right now so you know what to look for when you’re ready to buy.
In reality, the chances of you finding stocks on sale without a Rule #1 event are pretty slim, but when a Rule #1 event does occur, you’ll know what to do and be able to pick up high-value companies at low prices.
When you wait for this, ensure your company can recover, and be patient, you’ll gain more in the long run.
If you want a little more guidance before you start to invest in stocks, I offer an amazing free investing webinar every week that will help you find and buy stocks in wonderful businesses while they’re on sale.
Join me for the next one and feel even more confident in your ability to invest in quality businesses at the best time.
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.