2 Easy Ways to Spot Bargains

In a recent column, I described my agony over losing a very solid moneymaking opportunity -- all because I got careless and simply forgot to buy before it was too late.

The story seemed to strike a chord with readers, several of whom wrote to ask me a simple question: "How do you find cheap?"

Unfortunately, that question doesn't have a simple answer. (If it did, there would be no good opportunities out there for us value types.) Still, we've all got to start somewhere, and it never hurts for experienced investors to brush up on the basics. In the interests of any budding cheapskates out there, I pulled together two of the easiest ways I know to begin the hunt for cheap.

Back to book
The first criterion is definitely old-school, coming straight out of Benjamin Graham.

If a company is trading at or less than the value of its book value, or better yet, its tangible book value, it's probably cheap.

This may sound ridiculously simple -- so facile it's useless. A company trading for less than the value of hard assets like plants, property, inventory, and accounts receivable? Couldn't happen in today's liquid markets!

Ha! Opportunities like these do arise, although they often appear in scary, cyclical industries and commodities. We had a below-book-value situation with Wheeling Pittsburgh (NASDAQ:WPSC) -- the steel company whose 100% run-up I've missed for no good reason at all. More recently, it happened with Premium Standard Farms (NASDAQ:PORK), which has made a nice jump since a few weeks back, when it was trading near book. Yes, I missed that one, too, despite another sharp colleague pointing it out to me. (I'm serious -- don't forget to buy before it's too late.)

But beware: A below-book price alone doesn't make a company a bargain, even if academic research out there suggests that investing this way will help you clobber the market. When something sells near book, there's nearly always something wrong; the key for me is to make sure that the company's problems aren't terminal. Moreover, you need to be sure that the stuff that makes up book value is actually worth something. With useable factories and decent real estate, you're on OK footing. If you're talking about a retailer with out-of-favor inventory and leaseholder improvements that no one else will want, book value is less of a backstop.

Wave theory
I also believe (to some extent) that companies go in and out of favor with the market. A quick glance at any one-year chart is enough to confirm this for me. Short-term worries about the future of an entire sector or industry can punish good companies, even though their performance may not warrant the skepticism. The next rule is based on that observation.

If a growing, cash flow-positive company is trading at a 20% discount to its average P/E, it just might be cheap.

There are plenty of good reasons a company can become cheaper than its historical self, including dwindling growth or peak earnings season in a cyclical industry. However, when a firm that's still growing and producing free cash flow starts selling for a 20% discount to its usual price, I start to perk up. These bargains tend to come often among fashion retailers, where a single month's sales malaise can knock 20% off a stock price.

As long as a company isn't coming from a wildly overvalued multiple -- witness Travelzoo (NASDAQ:TZOO), which passed this screen a month ago -- I'll check in to see whether I think the market will change its mind and return to normal some time soon. Growing companies that are currently trading for that 20% discount include a lot of oil drillers (peak earnings fear), but also some more interesting plays, including these.

A final tip
Both of these rules of thumb are so simple that they can be used with just about any free online screener, such as those offered by Yahoo! or MSN. But remember the follow-through. As always in the markets, looks can be deceiving, and sometimes today's cheap is just a brief stop on the way to tomorrow's disaster. Once you find some likely prospects, be sure to read the recent news to find out why the market is offering the big discount. If the reasoning looks short-sighted and the fears overblown, it may be time to wade in.

And if you need some ideas for cheap stocks, and guidance on how to take the next steps in analyzing your prospects, we've got an entire team devoted to that very subject. Our market-beating newsletter, Motley Fool Inside Value, offers fresh recommendations, plus knowledge and strategies you can use on your own. Better yet, you can try it for free. Anyone can see how cheap that is.

Seth Jayson is always hunting for bargains. At the time of publication, he had positions in no company mentioned here. View his stock holdings and Fool profile here . Intel is an Inside Value pick. Fool rules arehere.