Are you right 100% of the time?

If so, you'd better hope that there's no one out there just like you -- and that you never trade a stock with that person. Because if you do, one of you has to be wrong.

Whenever you trade a stock, you're disagreeing with the person you're trading with. If you're buying, you think the stock is going up. The other side, of course, is selling. He or she thinks the stock is headed down.

Do you care what they think?
Expand these transactions over a larger scale, and you can see why the law of supply and demand more or less rules the trading floor. Too much supply? The price goes down. Too much demand? The price goes up.

And while each trade typically includes only an extremely tiny sliver of a company's total number of outstanding shares, the most recent trade directly affects the value of every share. In essence, a small sampling of opinions drives stock prices on a day-to-day basis.

That can be a scary realization if you have your life savings invested in the market. But it's actually a huge opportunity for you to make more money in the long run.

Dig up the facts
Even though opinions drive daily stock moves, facts drive long-term valuations. When there's a disconnect between market opinion and financial fact, you can profit handsomely.

To do so, you need to get a handle on the financial facts that best indicate a company's real worth. While that's impossible to know exactly, you can make a pretty good educated guess, based on a combination of company projections, analyst estimates, and proven track records.

Once you collect the data you need, you can run it through a discounted cash flow (DCF) calculation to estimate the value of a company's stock. Here's a rough-cut analysis for a handful of well-known firms:



Growth Rate



Percent Over
(Under) Valued

Cisco Systems (NASDAQ:CSCO)






General Electric (NYSE:GE)






Wyeth (NYSE:WYE)






Honeywell (NYSE:HON)






Reynolds American (NYSE:RAI)






Diageo (NYSE:DEO)






*In billions.

Verify the variance
Most of the time, the market does a pretty good job of pricing a stock. In this particular case, only Cisco and Diageo look out of line with my DCF estimate.

In Cisco's case, the difference can be explained away by the projected growth rate. The market is expecting Cisco to grow faster than I am.

On the flip side, adult beverage giant Diageo -- which looks like the biggest bargain of the lot -- suffers from a "sin stock" discount. Heavy regulation, taxation, and a large potential for lawsuits tend to cast a permanent pallor on such companies' stocks. The discount is a way of reflecting the extra risks the market senses in the company's operations.

So what?
If you pay fair value for a stock, you should end up earning the company's real growth rate, plus dividends over time. That's OK, but it won't help you beat the market by any significant margin.

When you pay less than fair value, however, you'll not only get a return alongside the growth rate, but you'll also profit significantly when the stock rebounds to fair value.

In Diageo's case, if the market decides it's been too negative in its risk assessment, you'll earn an extra 12%. But you can do even better.

Take the case of credit card giant MasterCard (NYSE:MA), which advisor Philip Durell recommended in our Motley Fool Inside Value service. Changes to bankruptcy laws, antitrust concerns, and past legal settlements had kept the company from being properly valued by the market. That gave our subscribers the chance to pick up shares at a tremendous discount. Its shares have more than tripled in the year since Philip made the call. And while MasterCard as a company has performed very well over the past year, much of our outsized return came from the company's rebound to fair value.

Find the next MasterCard
You need to focus on finding fire-sale opportunities. That's our tack at Inside Value, and our picks are beating the market by eight percentage points since our 2004 inception. We also offer a DCF calculator in the service to help you find discounted stocks on your own.

You can kick the tires on the calculator, and take a look at all of our research and recommendations, by joining the service free for 30 days. There's no obligation to subscribe. Click here for more information.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of General Electric. Diageo is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.