3 keys to undervalued stocks with big upside potential
THELow-cost stocks are what investment dreams are made of. We’ve all fantasized about buying a single digit stock and watching it soar.
Too often, however, investors never make this dream come true.
For a number of reasons, investors often buy a stock at a low price only to sell it at an even lower price. This common practice is really quite curable.
The mistakes investors make when dealing with cheap stocks have simple answers. Most of the time, you already know the answers; it is the execution that is hard. I want to share some of these common problems and give you the solutions so that you can become a better investor.
Beware of buying the background
Everyone wants to get something for nothing. If you can’t, paying as little as possible is the best alternative. I mean, let’s face it, who wouldn’t want to buy at the 52 week low and then sell at the 52 week high?
The problem is that sometimes the background you see isn’t the background at all. Usually stocks that hit new 52 week lows are not the stocks you should buy. The market tells you that this stock is always worth less and less when it appears on the 52 week low list.
Bottom feed is fine for some species, but investors who want good returns in a reasonable amount of time should avoid stocks at their “perceived” level. Always look for confirmation that the bottom is reached and the stock is recovering.
Adjust your risk profile
Buying a stock at a low price sometimes seems like a risk-free or very limited risk endeavor. The stock is in single digits and how much more can it go down? The answer to this is always the same.
Any stock can drop 100% from its previous day’s closing level. This rarely happens, but the point is, you need to think about percentage returns more than stock prices. A stock of $ 7 rising to $ 3.50 is a 50% loss and that is a hard number to swallow.
The solution to this problem is position sizing. You need to know how much of your portfolio should be devoted to low-cost stocks and not put all your eggs in one basket. This is a problem that is unique to each investor, as each has a different amount of dollars to invest and most also have a different time horizon. Proper sizing of the position will allow you to resist short-term losses and encourage long-term success as well.
Following . . .
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Do not double
Many investors believe that the stock they choose is destined to be successful. I mean, they did their research (scarce as it might be) and came up with the idea, so it probably has some merit, doesn’t it?
This type of confirmation bias leads many investors to overtake a bad idea. When an investor buys a stock at $ 8 and then doubles to $ 6, the problem only becomes more significant when the stock slips to $ 5. Now you have twice as many stocks and you lose more money with every tick!
The discipline of cutting off the losers and letting the winners run is something that even the most seasoned pro struggles with. Evaluate how much you are able to support in the event of a withdrawal and stick to those limits. Often times, low-cost stocks have a way to really fall out of bed when there are problems … and no one wants that.
My best advice for making big profits with cheap stocks
Be patient with your investments. Low-priced stocks generally need more time than their big brothers. A good dose of patience will go a long way for a cheap stock portfolio.
Take advantage of the Zacks Rankings to help you find stocks that analysts say are making more money. The Zacks Rankings examines revisions to model earnings estimates from all hedging analysts and compares them to all stocks in the Zacks hedging universe. When a Needham or William Blair analyst increases the numbers, Zacks’ ranking helps you know when the estimate increases are most significant.
Risk assessment is a difficult task and only you can do it. One way to limit the risk is to spread the exposure over several low-priced stocks. Instead of going “all in” and buying 10,000 shares of a single-digit security, divide them among several names. A larger portfolio will spread the risk across multiple stocks, giving you a better chance of success.
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Brian Bolan is our Aggressive Growth Expert and Editor-in-Chief of Zacks shares under $ 10 wallet.
¹ The results listed above are not (or may not be) representative of the performance of any selections made by the editors of the Zacks Investment Research newsletter and may represent the partial closing of a position.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.