Finding Value Winners

The other day, I wrote about the concept of a "margin of safety" and how a portfolio of stocks bought below their intrinsic values was more likely to hold its ground during a market correction -- as well as being very likely to show strong gains over time. My fellow Fool Chuck Saletta has taken that concept one step further, making a strong case for the idea that buying value-priced and smaller-cap stocks are the ways for individual investors to consistently outperform institutional investors and the broader market. And a while back, Fool David Meier talked about the discounted cash flow method of stock valuation, a useful way to help guesstimate a company's intrinsic value and determine the potential margin of safety.

So we know that value stocks are great, we know that they're one of the few places where an individual has a market-beating advantage over institutional investors, and we know how to tell whether a value candidate really has a margin of safety. There's just one thing we don't know: where do we find these things?

Even if we limit ourselves to U.S. stocks with market caps over $50 million, we're still talking about more than 3,000 stocks ... and we need to find a dozen or so, possibly obscure, names in that pile. How do we do it?

Screen test
The most commonly used approach is to employ a stock screener, a simple search tool that finds stocks that meet certain criteria. MarketWatch and Yahoo! both offer free basic screeners, and discount brokers such as Charles Schwab (Nasdaq: SCHW), E*Trade (Nasdaq: ETFC), and Fidelity all make stock screeners available to their clients at no charge. And if you're really serious about screening, you might want to consider paying up for the excellent Stock Investor Pro service, a popular choice among serious individual investors (including many professional Fools).

Of course, a screener isn't of much use unless you know what to tell it. While it will take some experimentation to get good results out of any given screener, I suggest you start by setting it to look for smaller cap stocks (under $2 billion or so) with low price-to-earnings ratios, high projected growth, and strong margins. Using those criteria with Fidelity's stock screener, I just generated a list of seven stock candidates that included natural-gas land driller Union Drilling (Nasdaq: UDRL) and San Juan Basin Royalty Trust (NYSE: SJT), a company that holds oil and gas interests in a big swath of property in New Mexico, both of which look like promising candidates for further research.

Donning your CAPS
For me, the next step after a stock screen is to look at what the players on Motley Fool CAPS have to say about each of the most promising candidates. Simply hop over to the site, enter the ticker, and click to get a page of info on the stock. The page includes several things. You'll find a star rating, which sums up the community's opinion on the stock -- giving more weight to the opinions of those with the best track records. You'll get to read "pitches," where players make the bull or bear case for the stock. In addition, you'll get some basic market and financial info, and links to news stories and other discussions about the stock from around The Motley Fool. While it's definitely not a substitute for the in-depth research you should do before buying, spending a few minutes on a stock's CAPS page -- and following the links to stories and Fool message board discussions about the stock -- can give you an idea of recent developments and key issues facing the company, which are great places to start your research. If you want to get started right now, go have a look at what CAPS has to say about San Juan Basin and Union Drilling and see what you think.

If you don't have time to do your own research, but still want to find promising small-cap values, let the Motley Fool Hidden Gems newsletter service simplify your life. Every month, Fool co-founder Tom Gardner and longtime Fool stock analyst Bill Mann offer up their best small-stock ideas, backed by in-depth research, easy-to-understand summaries, a great members-only discussion board, and a track record that is currently beating the market by 37% since the service's inception. You can see Hidden Gems free for 30 days. There is no obligation to subscribe.

Fool contributor John Rosevear owns a bunch of small-cap value stocks and peeks at the Hidden Gems boards several times a week, but does not own any of the stocks mentioned in this article. Schwab is a Stock Advisor recommendation. The Motley Fool has a disclosure policy.