Investing

How to pick the undervalued/high potential stock to buy ?

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  • Feb 5th, 2020 5:49 pm
Deal Guru
Jun 7, 2005
10358 posts
1481 upvotes
Toronto

How to pick the undervalued/high potential stock to buy ?

I know this is like a million $ question.

I noticed Tesla has gone up almost 4 folds since last May. Missed the golden opportunity......... I wonder what should I look at if I am searching for the next undervalued/high potential stock ?

Or if I don't know much and lack of stock investing experience, I should just stick with the couch potato approach and buy index funds only ? I have extra savings now which have been sitting in the cash account as I am worried that I put it into the wrong bucket again. I am kind of scared because of some bad experience, e.g. bought some Canada Goose stock at $72 as analyst said it will go over $100 in no time and it went as expected in the beginning but it is now $42 !!! And I don't know if I should sell it now or keep holding & waiting (Actually same question for other stocks that in a loss position e.g. Roots (so regretted to buy it at time when I bought Canada Goose, as it has been going down ever since I bought it) , Other than Index Fund, the only stock I found it has been having promising return is Enbridge. I wonder if I should buy more of it and make it as DRIP since it is pretty decent dividends.

My immediate question now if and when I should sell those bad stocks that have been in loss position for over a year.

Thanks for any advice, and sorry for any dumb questions.
6 replies
Deal Fanatic
User avatar
May 11, 2014
6582 posts
9090 upvotes
Rankin Inlet, NU
rdx wrote: I know this is like a million $ question.

I noticed Tesla has gone up almost 4 folds since last May. Missed the golden opportunity......... I wonder what should I look at if I am searching for the next undervalued/high potential stock ?

Or if I don't know much and lack of stock investing experience, I should just stick with the couch potato approach and buy index funds only ? I have extra savings now which have been sitting in the cash account as I am worried that I put it into the wrong bucket again. I am kind of scared because of some bad experience, e.g. bought some Canada Goose stock at $72 as analyst said it will go over $100 in no time and it went as expected in the beginning but it is now $42 !!! And I don't know if I should sell it now or keep holding & waiting (Actually same question for other stocks that in a loss position e.g. Roots (so regretted to buy it at time when I bought Canada Goose, as it has been going down ever since I bought it) , Other than Index Fund, the only stock I found it has been having promising return is Enbridge. I wonder if I should buy more of it and make it as DRIP since it is pretty decent dividends.

My immediate question now if and when I should sell those bad stocks that have been in loss position for over a year.

Thanks for any advice, and sorry for any dumb questions.
These bolded sentences highlight your biggest problem: You have no strategy or investment knowledge. You are merely chasing return hoping that buying this will just go up with little to no understanding of why it is a worthwhile investment or not. Sure Tesla went up 3-4x, but I would never buy it, even if the price is back to what it was a few months ago I would still not touch it. It doesn't fit my parameters for investment. Market forces like the high short float and large amount of market demand fearing that they might lose out without investing likely is pushing the price higher. Additionally, profitability of the company is still lacking and there are still many issues needed to be sorted out. There are also huge risks such as regulatory and potential for many vested industry players and newcomers that could crowd the market.

For Canada Goose, you bought it because an analyst said it would be over $100. Let's explore further: can you answer why it was going to be over $100? Did you look at the investment thesis for this analyst to say it would go that high? What made that analyst say the company's value would go that much up? Also, more importantly, why did that not pan out?

If you cannot answer this question, this means your research into what you are investing in individual stocks is weak.

There is no single strategy out there. Many posters here follow different strategies, all which fit within their overall financial situation and may not necessarily be right for you. Additionally the risk one can tolerate isn't necessarily appropriate for yourself either.

I will divulge my strategy. I have always been a value investor. I look for stock and companies that are undervalued or "underappreciated" by the market place. In order for my strategy to succeed, this means I need to understand the business that a company is in, how they make money, how much assets and debts they have, and as a business, how they plan to grow their business, earnings and in finality their stock price.

Let's take one of my biggest investment successes, which is AIr Canada. I started buying shares at $2-3 a share. I have sold and re-entered the stock multiple times. About 8-9 years ago, Air Canada almost went bankrupt as their pension plan nearly bankrupted them. Additionally, labour relations were terrible, a strike imminent etc. When the CEO came in, he took a plan to stabilize the company by first by solving the acute issues such as the strike, insolvent pension plan etc. He got a big 10 year deal from the unions, he got government guarantees on the pension (considering a lot of the debt can be attributed from the past government ownership of the airline), and he started a plan to cut costs and improve margins. This included making lower cost subsidies to take over unprofitable routes (Rouge), and finding ways to reduce inefficiencies. He then looked at where AIr Canada needed investments. In this case it was logistical, and new fuel-efficient airplanes. While it cost alot, spending money buying fuel efficient airplanes was needed for longer term benefits. The CEO also looked at what business to expand into. He focused on building Canada as a hub for traffic to and from the US. He focused on building a business around clearing passengers in Canada's much nicer airports with pre US clearing. Add the fact that Air Canada had multiple small hubs it can utilize to do this, less competitors in the Canadian domestic market, general lower costs due to the Canadian dollar, lower fuel costs and the fact that Air Canada had comparable service standards to US carriers, and in some cases, better, it became easy for Air Canada to take market share and grow their business. With the fuel efficient airplanes, AIr Canada could build routes to places that would normally be unprofitable. Destinations like Milan, Osaka, Brisbane, Copenhagen etc. have been added overtime.
Air Canada had the right strategy, came from a low valuation due to fears of bankruptcy (market just judged shares as uninvestable), a balance sheet and cash flow that can work/survive, and were in an industry that was growing.

The salient point to my strategy is that it has to hit those main things for an investment to be worthy. Let's then compare that to others.

Westjet for example is something I like to contrast Air Canada to.
-In an expanding industry?- Y
-Good Balance sheet and cashflow?-Y
-Share value low?- Questionable, from medium to high
-Strategy?- N

Westjet has/had a good reputation. People would pick them over Air Canada. The value of the brand was mainly that it wasn't Air Canada. They differentiated themselves as a friendly, low-cost alternative. Then the former CEO tried improving profitability. Bag charges were introduced, fares became similar to Air Canada, there was labour grumblings as wages became noncompetitive and any movements toward unionization was just met with scorn. Then the issue came with strategy. Westjet realized it was behind in it's strategy. Air Canada was expanding and had a successful low cost system. Westjet also had little area to grow in domestic flights. They started aggressively investing in all areas. The problem though was the expansion was not well hashed. They bought old airplanes that broke down angering many customers. Their regional product wasn't well hashed out. They had no major partners to feed traffic. They focused on a single city (London) where there is so much competition. Then they changed tack and bought expensive airplanes. Their low cost product Swoop took away airplanes from their mainline and attempted to cut costs further, but angered their pilots even more.

The stock went down and sideways before being bought out. The thing is they would have been OK in the long run, but the value of the shares was already somewhat high due to people liking them in general and already owning them. This mean there wasn't room to grow.

Then let's not look at individual companies but general industries. Let's take oil industry. There are many well run oil and gas companies out there. But no matter how well run they are, the thing is those main points have to be maintained for it to be a worthwhile investment. The oil market is stagnant at the moment. There is a lot of concerns about oversupply. We also have a world where reduction of the use of fossil fuels is becoming more and more mainstream. We have renewable energy supplies becoming cost effective. We also have many oil producing countries having financial problems meaning that OPEC members are often trying to sell more than their quota to increase revenues. Development of shale oil has reduced the price further. Do you see the problem here? While there are many oil companies that might be well managed, an industry with many potential problems reduces your potential for the stock to grow in price.

This is getting long. My main point is you seem to lack any general investment research and knowledge. There is a lot you should try to learn or at least understand. I believe understanding how company valuation works is the most important thing you need before you start investing in individual companies. Of course you can take simpler strategies or ones with specific rules. Dividend Growth is a strategy that requires a little less time investment. Or you could even elect to take an index strategy as you mention which requires little to no research time whatsoever.

As for when to sell a stock, I generally go by two rules: does the stock still meet my parameters for investment? (If I had the dollar amount they are worth in cash, would I buy the shares?) and are the reasons for when I bought the shares still valid?
Since you have no strategy that I can discern, my advice would be to sell and start over. Remember, investing is generally a long term game and you need to build from somewhere. As a beginner, I wouldn't recommend you go into straight stocks without knowing basic mechanism of what shares are, understanding some knowledge of looking at financial numbers and trying to understand how a company/business operates. You could always elect to accumulate most of your wealth with passive investments and slowly take on some individual stocks. I would recommend this for you so you at least keep some baseline investments that can be held longer term and you can slowly build your knowledge overtime to be able to invest in individual stocks.
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Deal Expert
Jan 27, 2006
21844 posts
15620 upvotes
Vancouver, BC
A good way to hone your skills is to set up a practice account so that you can practice your ideas to see if they pan out over a period of time. Of course that means having to wait and learn from your mistakes but at least those mistakes won't cost you anything while you save up funds for your investments.

As for methodology, as @xgbsSS stated above, there multiple different ways and means to get from A to B with some of them getting you faster but with higher risk and some slower but with lower risk. The key to ANY methodology is to understand the underlying principles for that methodology (ie understand why it works, why it doesn't work, and how it works...) rather than just listening to someone, website, blog, chatroom say their way is the perfect way for everyone as you don't need to know anything about it if you do A, B, then C. By understanding the methodologies, you can develop a strategy (ie financial/investment plan).

Personally, I run multiple methodologies as part of my strategy and how much I may have invested in a particular methodology changes depending on what's going on in the macro-environment. For example, one methodology I use is to look for longer-term trends that are investible which is one of the reasons why I purchased LULU at $66 years ago. Did it go up like a rocket ship? No. LULU had some issues which dropped the stock into the $40s for a while but the story, for the most part, stayed intact through all of the troubles with the founder, then firing of the CEO... I'm also invested in GOOS but I got in at $27 and will be staying in as the story, to me at least, remains intact much like LULU was when it was going through it's troubles. I also have a couple of index ETFs for foreign markets that I want exposure to but can't really get it through stocks as I don't want to research the companies as the information available is in another language and the cost involved to trade those stocks is relatively high so I run that part of my portfolio using a passive index. I also invest in rocket ship type stocks that I have a firm understanding of what the environment is for them and the story of the stock which is why I'm in AMD (once from $11 to $30 and then again from $9 to the current price of just under $50).

Speaking of those rocket ship stocks, NEVER feel bad about missing one or two or five of them as like a subway car, there will be another coming around the bend shortly. You still have time get on the next one but you want to check where that one is going before just jumping on board.
Deal Fanatic
Jul 23, 2007
5132 posts
4926 upvotes
Nothing like Tesla. I don't know how to pick them, but I seem to occasionally get a multibagger after a stock has been a few years in the portfolio. A couple of ADR's I bought in the late 1990's went towards a good chunk of the downpayment on the house we bought. Timing to sell was right because they both later took a pounding in the tech crash although only one was a techy stock. Made up for a few outright disasters a couple of years later like Nortel and JDS Uniphase.

Bought a Canadian equity in 2010 but found it too hot handle after it became a seven bagger by 2015, so ended up selling it. Left some money on the table, but not very good at seeing the top. Bought another Canadian one a year earlier in 2009 and it's a bit slower and is now up about five times what I paid for it.

The only thing they all had in common were that they were bought at what I considered a reasonable price at the time and all paid a growing dividend.

Growth of assets in the portfolio during a bull market is nice, but I always just keep focused on the dividend and that seems to be what works best for myself. If I reach too far, I usually end up making a mess of things.

Save, invest, re-invest. Keep investing simple whether it's active investing or just plain global indexing. Nothing too difficult.
Deal Addict
Jun 18, 2018
1984 posts
1454 upvotes
Toronto
Some great advice on here. I will just add that diversifying your portfolio of stocks in terms of industry is also important. I know people who are heavily invested in tech, and while that has sparked great returns for them, it also carries a lot of risk.
Deal Expert
Jan 27, 2006
21844 posts
15620 upvotes
Vancouver, BC
Electrah wrote: I know people who are heavily invested in tech, and while that has sparked great returns for them, it also carries a lot of risk.
IMHO, that's OKAY as long as you know the risk involved and understand the underlying story behind them. Where issues arise is when people don't understand the risk involved and the underlying story!

For example, the S&P500's 10 largest cap companies consist of 3 financials, 1 pharma and 6 tech (or 'former tech') companies and they make up about 22% of the index? And those 6 tech companies are 17% of the index? Therefore anyone solely invested in the S&P500 via an index fund is basically heavily invested in tech? I doubt many investors know this...
Deal Guru
Jun 7, 2005
10358 posts
1481 upvotes
Toronto
Thanks a lot for the details.
xgbsSS wrote: These bolded sentences highlight your biggest problem: You have no strategy or investment knowledge. You are merely chasing return hoping that buying this will just go up with little to no understanding of why it is a worthwhile investment or not. Sure Tesla went up 3-4x, but I would never buy it, even if the price is back to what it was a few months ago I would still not touch it. It doesn't fit my parameters for investment. Market forces like the high short float and large amount of market demand fearing that they might lose out without investing likely is pushing the price higher. Additionally, profitability of the company is still lacking and there are still many issues needed to be sorted out. There are also huge risks such as regulatory and potential for many vested industry players and newcomers that could crowd the market.

For Canada Goose, you bought it because an analyst said it would be over $100. Let's explore further: can you answer why it was going to be over $100? Did you look at the investment thesis for this analyst to say it would go that high? What made that analyst say the company's value would go that much up? Also, more importantly, why did that not pan out?

If you cannot answer this question, this means your research into what you are investing in individual stocks is weak.

There is no single strategy out there. Many posters here follow different strategies, all which fit within their overall financial situation and may not necessarily be right for you. Additionally the risk one can tolerate isn't necessarily appropriate for yourself either.

I will divulge my strategy. I have always been a value investor. I look for stock and companies that are undervalued or "underappreciated" by the market place. In order for my strategy to succeed, this means I need to understand the business that a company is in, how they make money, how much assets and debts they have, and as a business, how they plan to grow their business, earnings and in finality their stock price.

Let's take one of my biggest investment successes, which is AIr Canada. I started buying shares at $2-3 a share. I have sold and re-entered the stock multiple times. About 8-9 years ago, Air Canada almost went bankrupt as their pension plan nearly bankrupted them. Additionally, labour relations were terrible, a strike imminent etc. When the CEO came in, he took a plan to stabilize the company by first by solving the acute issues such as the strike, insolvent pension plan etc. He got a big 10 year deal from the unions, he got government guarantees on the pension (considering a lot of the debt can be attributed from the past government ownership of the airline), and he started a plan to cut costs and improve margins. This included making lower cost subsidies to take over unprofitable routes (Rouge), and finding ways to reduce inefficiencies. He then looked at where AIr Canada needed investments. In this case it was logistical, and new fuel-efficient airplanes. While it cost alot, spending money buying fuel efficient airplanes was needed for longer term benefits. The CEO also looked at what business to expand into. He focused on building Canada as a hub for traffic to and from the US. He focused on building a business around clearing passengers in Canada's much nicer airports with pre US clearing. Add the fact that Air Canada had multiple small hubs it can utilize to do this, less competitors in the Canadian domestic market, general lower costs due to the Canadian dollar, lower fuel costs and the fact that Air Canada had comparable service standards to US carriers, and in some cases, better, it became easy for Air Canada to take market share and grow their business. With the fuel efficient airplanes, AIr Canada could build routes to places that would normally be unprofitable. Destinations like Milan, Osaka, Brisbane, Copenhagen etc. have been added overtime.
Air Canada had the right strategy, came from a low valuation due to fears of bankruptcy (market just judged shares as uninvestable), a balance sheet and cash flow that can work/survive, and were in an industry that was growing.

The salient point to my strategy is that it has to hit those main things for an investment to be worthy. Let's then compare that to others.

Westjet for example is something I like to contrast Air Canada to.
-In an expanding industry?- Y
-Good Balance sheet and cashflow?-Y
-Share value low?- Questionable, from medium to high
-Strategy?- N

Westjet has/had a good reputation. People would pick them over Air Canada. The value of the brand was mainly that it wasn't Air Canada. They differentiated themselves as a friendly, low-cost alternative. Then the former CEO tried improving profitability. Bag charges were introduced, fares became similar to Air Canada, there was labour grumblings as wages became noncompetitive and any movements toward unionization was just met with scorn. Then the issue came with strategy. Westjet realized it was behind in it's strategy. Air Canada was expanding and had a successful low cost system. Westjet also had little area to grow in domestic flights. They started aggressively investing in all areas. The problem though was the expansion was not well hashed. They bought old airplanes that broke down angering many customers. Their regional product wasn't well hashed out. They had no major partners to feed traffic. They focused on a single city (London) where there is so much competition. Then they changed tack and bought expensive airplanes. Their low cost product Swoop took away airplanes from their mainline and attempted to cut costs further, but angered their pilots even more.

The stock went down and sideways before being bought out. The thing is they would have been OK in the long run, but the value of the shares was already somewhat high due to people liking them in general and already owning them. This mean there wasn't room to grow.

Then let's not look at individual companies but general industries. Let's take oil industry. There are many well run oil and gas companies out there. But no matter how well run they are, the thing is those main points have to be maintained for it to be a worthwhile investment. The oil market is stagnant at the moment. There is a lot of concerns about oversupply. We also have a world where reduction of the use of fossil fuels is becoming more and more mainstream. We have renewable energy supplies becoming cost effective. We also have many oil producing countries having financial problems meaning that OPEC members are often trying to sell more than their quota to increase revenues. Development of shale oil has reduced the price further. Do you see the problem here? While there are many oil companies that might be well managed, an industry with many potential problems reduces your potential for the stock to grow in price.

This is getting long. My main point is you seem to lack any general investment research and knowledge. There is a lot you should try to learn or at least understand. I believe understanding how company valuation works is the most important thing you need before you start investing in individual companies. Of course you can take simpler strategies or ones with specific rules. Dividend Growth is a strategy that requires a little less time investment. Or you could even elect to take an index strategy as you mention which requires little to no research time whatsoever.

As for when to sell a stock, I generally go by two rules: does the stock still meet my parameters for investment? (If I had the dollar amount they are worth in cash, would I buy the shares?) and are the reasons for when I bought the shares still valid?
Since you have no strategy that I can discern, my advice would be to sell and start over. Remember, investing is generally a long term game and you need to build from somewhere. As a beginner, I wouldn't recommend you go into straight stocks without knowing basic mechanism of what shares are, understanding some knowledge of looking at financial numbers and trying to understand how a company/business operates. You could always elect to accumulate most of your wealth with passive investments and slowly take on some individual stocks. I would recommend this for you so you at least keep some baseline investments that can be held longer term and you can slowly build your knowledge overtime to be able to invest in individual stocks.

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