Many investors love to buy cheap stocks, but as Mr O’Neil ( puts it: “Stocks are cheap for a reason”. In many (but not ALL) cases, investors do not realize that the stocks they bought cheaply belongs to a company mired in problems with slowing earnings, sales growth and shrinking market share. These are bad traits for a stock to have, regardless of how cheap it is.

Nonetheless, although most investors have lost money buying cheap stocks, there are still many savvy investors (read: Warren Buffett) who have made fortunes buying cheap BUT GOOD stocks. How did they do it? Below are some guidelines:

Buy a business, not a stock.

When evaluating a stock, see yourself as a business owner, not a stock investor. Only buy businesses that you understand. When you understand a business, you will be able to evaluate important questions like: Is the company’s stock cheap because it is losing market share? What are the challenges faced by the company?

Buy stocks in companies that have a proven track record.

This includes a consistently good EPS, sales, equity and free cash flow growth rate and a long history of great ROIC (above 10{3d5275f9508c9dd4021075398e098e5db9cf49de07ee931b769af6a77a0ab5ee} for the last 10 years).

Buy stocks that have a big MOAT

A moat is a ‘protective shield’ that a company has that prevents other companies from invading their territory. Examples of moats include

  • Brand name: The company has a very strong brand name, making it difficult for other companies to compete with them. An excellent example is “Apple”, with its group of die-hard fans.
  • Secret: The company has a patent or trade secret that makes competition illegal or very difficult. Example: 3M.

Buy stocks with a good and honest management

Traits of honest management include admitting their mistakes (if the company did not do well for one quarter, they should admit it and explain how they intend to improve the situation) and accepting a reasonable compensation for their work.

How to buy Cheap Stocks?

At this point, you may be wondering: If a company has such an excellent track record and characteristics, why is the stock cheap?

Most of the time, these companies stocks are cheap because of a temporary problem (such as missing EPS estimate) or because the overall market is bearish. At times like this, you can normally buy the stocks cheaply, preferable at a 50{3d5275f9508c9dd4021075398e098e5db9cf49de07ee931b769af6a77a0ab5ee} discount.

As long as one does his/her research diligently and is willing to wait patiently for a good price, he/she can definitely join the ranks of successful investors. A bear market (which is NOW) presents the best buying opportunities.