Brushing Up on Value

When it comes to picking stocks, I shop for value, pretty much the same way I shop for toothpaste. In investing, the biggest challenge is sifting through the number of choices. As for toothpaste, check out the bewildering array in the oral-care aisle of your local CVS or Walgreen. There are dozens of brands, offering an incredible range of choice: paste, gel, cavity protection, tartar protection, breath control, antimicrobial, desensitizing, whitening, for kids, and flavors galore. How on earth do you decide?

A little research, please
The most extensive independent research on toothpaste I've seen was conducted a few years back by Consumer Reports. It hired two labs to test 39 products on cow's teeth stained with a nasty mix of coffee, food, bacteria, and assorted chemicals -- pretty much your standard American diet. Researchers checked for abrasiveness, cleaning effectiveness, and fluoride release. Guess what? They found minimal difference. In fact, based on their findings, the magazine gave its "excellent" rating to 30 of the products. After reading the article, I concluded that the one significant difference in toothpaste shows up not in your mouth but at the cash register.

Being a value type of guy, the most I'll pay for a six-ounce tube is a buck. Most recently, that was a tube of Procter & Gamble's budget offering, Gleem, from Dollar Tree Stores (NASDAQ:DLTR). I'm confident I'm maintaining my dental health as effectively as if I'd spent three times as much for the latest offering from Colgate-Palmolive. And speaking of which, I've just clipped an Eckerd Pharmacy "Free-Bate" coupon for a tube of Colgate's new Luminous, available in three enticing flavors. The sale price is $2.49 minus the $2.49 rebate -- free! You can see that I'm definitely the type to look for bargains.

Easier than brushing cows' teeth
When selecting products like toothpaste, I rely on Consumer Reports and similar publications to help me identify quality. I don't mind doing a bit of personal research, but I'll let others brush the cow's teeth. When searching for value stocks, my approach is similar. I read the business news and occasionally look up the key numbers in earnings reports. But these days, I count on Motley FoolInsideValue to help me find superior companies at discount prices.

You might wonder how that works. I mean, brushing cows' teeth in a laboratory and measuring the results is understandable, if not very appealing. But what's the Inside Value process for picking stocks?

Actually, the process is equally understandable. Philip Durell, the Motley Fool analyst who leads the Inside Value team, explains that stocks have intrinsic values that can be calculated. However, at any point in time, the market price for a stock can deviate dramatically from its true worth. It seems that your average Joe and Josephine investor can be a fickle lot. They occasionally lose all interest in a stock that a few quarters earlier they just couldn't buy fast enough. As evidence of investor fickleness, consider the five stocks below. Can anyone imagine that the intrinsic value of these multibillion-dollar companies actually changed by 52% to 75% in the space of one year?

The value strategy is to keep an eye on intrinsic value and wait patiently until the stock falls out of favor and trades at a substantial discount. Philip refers to this discount as the "margin of safety," using a term popularized by Benjamin Graham and his followers, including Warren Buffett.

Simple concept, yes, but it does require patience and the ability to calculate intrinsic value. Subscribers to Inside Value have ample opportunity to acquire those skills from newsletter articles, special features, interviews with experts, and discussion boards with knowledgeable participants. Best of all, each month Philip picks two stocks that are trading at a significant discount to intrinsic value, and he explains how he arrives at his valuations. He records what the price was when he recommended the stock and also sets a "buy below" price that provides the "margin of safety" that value investors prize. So you can either take advantage of these newsletter picks, learn from the masters, or do what I do, which is a bit of both.

A case in point is the aforementioned Dollar Tree, my favorite source for toothpaste and one of Philip's picks last August. I used Philip's analysis as a study guide for value investing and watched the discount from his valuation grow yet more attractive. While I passed up that buying opportunity, what I learned increased my confidence in the approach.

My Foolish disclosure
As I write this, my portfolio of three dozen individual stocks includes 10 that also appear on the Inside Value scorecard. You can see all my stock holdings at my Fool profile. And you can find out which ones are Inside Value picks by clicking here for a free 30-day trial. Subscribe today, and you'll also receive a free copy of Around the World in 80 Minutes, the Fool's report on international investing, which reviews companies that appeal to a wide range of investing styles, including some for us value hounds.

At the time of publication, Fool contributor Doug Short owned shares of Procter & Gamble, Amgen, and Paychex. Dollar Tree and Colgate-Palmolive are Inside Value picks. eBay is a Stock Advisor pick. The Fool has an ironcladdisclosure policy.