The stock market isn't all that different from the supermarket. Value investors -- like bargain-conscious grocery shoppers -- want to own shares of superior companies, but only if those companies are going for the right price.
Want to be a better investor? Here's one very simple idea: Invest like you shop. Ever traveled several miles out of your way to save a nickel per gallon of gasoline? Ever purchased a 6-pound block of cheese at Costco to save a few bucks? Ever sifted through bins to find an Armani necktie at T.J. Maxx?
You see, there are plenty of Armanis hidden in the market's bargain bins. For one reason or another, there are stocks that have been discarded or downgraded with little thought to the underlying business. And therein lies your opportunity.
Attention, value shoppers
At Motley Fool Inside Value, we obsessively scour the public markets for undervalued dream stocks. We believe in finding superior companies -- at the right price.
Take Altria (NYSE:MO), for example. The best-performing S&P stock since 1950 was dumped on in 2003. Investor fears of litigation and rising consumption taxes sent shares of Altria down to the mid-$20s just two years ago. Today, they fetch nearly $67.
For those scoring at home, that's 165% gain in only two years' time. In the words of value godfather Benjamin Graham, Altria had a huge "margin of safety" -- cushioning investors against bad news and giving Altria plenty of room to run.
Clip your coupons, get out your calculator
Altria might be a superb historical example, but it's certainly not the only one. Just take a look at the stock charts of Kinder Morgan (NYSE:KMI) and Nike (NYSE:NKE).
Some hocus-pocus Wall Street-types would have you believe that the process is inherently complicated. It's not. Or, at least, it doesn't have to be. Take a page from Inside Value analyst Philip Durell's book, and begin your hunt with a simple three-step process.
Step 1: Make a list of all the great companies off the top of your head you wish you could own. For me: Allstate (NYSE:ALL), Covance (NYSE:CVD), and UPS (NYSE:UPS). Have your companies? Good.
Step 2: Carefully calculate their intrinsic values using a discounted cash flow (DCF) or dividend discount method (if you're interested, there's an easy-to-use DCF calculator available on the Inside Value website). Philip does this each month for the hundreds of superior companies he has spent years compiling on his watch list. The intrinsic value is, simply, the company's fair market price.
Step 3: Subtract a margin of safety -- the discount you need for that company to be cushioned against bad news and have plenty of room to run. If the market price is less than that number, then, well, you just might have a bargain-bin beauty.
Price matters
If you're overwhelmed, don't be. Calculating fair value is something you can get the hang of. Or, if you're interested, Philip is offering a 30-day free trial to Inside Value. You can try your own hand with our DCF calculator, which will help the do-it-yourselfers get started on that valuation process.
Of course, you'll also get Philip's two best stock picks every month -- and since inception, Inside Value picks are nearly tripling (9.1% vs. 3.06%) the returns of the S&P 500 -- and full access to intrinsic value estimates and buy-below prices for all 22 current picks to date. Click here to join the hunt for the market's buried bargains.
This article was originally published on Nov. 23, 2004. It has been updated.
Fool contributor and Inside Value team memberChuck Saletta owns shares of Kinder Morgan Management, an affiliated firm of Kinder Morgan. The Motley Fool has adisclosure policy.
