Waiting for Prices

I've heard about a lot of people using limit orders to try to grab stocks on the cheap. For instance, if you're interested in buying Amazon.com (NASDAQ:AMZN), but you don't want to pay the current price in the upper $40s, you can pace a limit order that will automatically buy shares for you if they drop to, say, $40. Fair enough, right?

Well, I’m actually of two minds here. On the one hand, placing  a limit order can make sense. If you think, for example, that the stock is worth around $45 per share, buying it at $47 isn’t too sensible. But buying it at $40 would only be offering an upside of around 13%. You can invest with a greater margin of safety by seeking out stocks that are trading at greater discounts to your estimates of their intrinsic worth. So if you think Amazon is worth $45, perhaps look to buy it for $35 or less, with a possible upside of 29%.

Meanwhile, if you think Amazon’s real value should be $65 right now, I’d think twice about waiting for that $40 price to trigger your purchase. Sure, getting it at $40 would offer an upside of 63%. But it might never drop to $40, and you can end up out of luck. If you buy at $47, your upside potential is still significant, at 38%.

Limit orders can help you get a better price, but they can also end up locking you out of some stocks worth owning.

Seeking value
If you want to find companies that are trading at significant discounts to their intrinsic value, a good way to start is to screen for stocks with P/E ratios well below their usual average. Here are some I found via MSNMoney.com’s screener:

Data from MSN.com.

Once you gather some candidates, you’ll need to examine a bunch of other factors, such as their financial health (lots of cash or debt?), their growth rates and prospects, and their competitive strengths. The results should give you some great companies to invest in.