by Dan Burrows | December 5, 2013 11:58 am
Finding cheap stocks to buy now is getting harder and harder. That’s what happens when markets are notching all-time highs. And that can create serious pitfalls for investors trying to find the best cheap stocks.
There are different ways of thinking about cheap stocks to buy — and some are better than others. Some penny stocks may look like the best cheap stock to buy now because of their low nominal value, but that does not necessarily make them truly cheap. (Not when they go to zero.)
Then there are value stocks. These really are the best cheap stocks to buy now — even if the nominal or face price is, say, $500. If it later goes up to $600, well, you indeed found yourself one of the top cheap stocks.
And let’s not forget about exchange-traded funds as one the best sources for cheap stocks to buy. ETFs can offer one-stop-shopping for a diverse basket of cheap stocks to buy.
Here’s a quick look at three ways to find the best cheap stocks to buy now:
Penny stock often look like the best cheap stocks to buy now. Hey, you sure can load up on a lot of shares when they go for 10 cents a pop. And it’s a heck of a lot easier for a 10-cent stock to double to 20 cents than it is for a $100 stock to double to $200.
Too bad you should run from most penny stocks like the plague, even though they definitely look like great cheap stocks to buy. Penny stocks trade over-the-counter — not on a major exchange. They are not subject to stringent listing requirements. Even worse, they’re not subject to the same kind of regulatory scrutiny by the Securities Exchange Commission. As the SEC warns:
“Penny stocks are generally considered speculative investments. Consequently, investors in penny stocks should be prepared for the possibility that they may lose their whole investment (or an amount in excess of their investment if they purchased penny stocks on margin).”
Some penny stocks eventually graduate from the OTC market to Nasdaq or NYSE. Indeed, InvestorPlace recently looked at a number of medical marijuana stocks like Medical Marijuana Inc. (MJNA) and Growlife (PHOT) that are penny stocks with some promise.
But most penny stocks don’t make it to the big leagues. And because they are so “cheap” at just pennies are share — and very illiquid — it’s easy for scammers to pump-and-dump these issues. All in all, penny stocks might look like some of the best cheap stocks to buy now, but they’re very risky and could cost you dearly.
Value stocks really are cheap stocks to buy now. Indeed, value stocks are what made Warren Buffett worth nearly $60 billion today.
When a professional investor says a stock is cheap, he or she isn’t talking about the nominal or face value. A $1,000 stock could be one of the best cheap stocks to buy now if the company’s intrinsic value is under-appreciated — and eventually makes it go up to $2,000. By the same token, a $10 stock is expensive if its intrinsic value is over-estimated — and shares eventually collapse to $2.
Value stocks are often stocks that have fallen out of favor with the market. For whatever reason, the bulk of market participants think there’s not much growth or upside ahead, so these securities tend to trade at low valuations — like a low price-to-earnings multiple (P/E) or low price-to-book (P/B).
Eventually, however, true value stocks prove the market wrong. It turns out that, hey, the intrinsic value of the company was mispriced — and the value stock goes up accordingly. The rub? True value stocks aren’t that easy to find. (Most of the time, cheap stocks to buy now are cheap for a reason.) Some value stocks InvestorPlace is bullish on include Avis (CAR) and Siemens (SI).
Be forewarned that even when you do find value stocks that are a few of the best cheap stocks to buy now, it often takes years — or decades — for the market to prove you right. After all, 20 years ago Warren Buffett was worth “only” $8 billion.
What is an ETF? Well, it’s kind of like an index fund — that is, a mutual fund that just passively tracks an index like the S&P 500. But ETFs have several advantages over mutual funds. For one thing, they boast the lowest fees you can find — a key consideration when searching for the best cheap stocks to buy now. After all, management fees erode returns.
ETFs have a lot of other things going for them. Mutual funds price once a day, but ETFs trade all day long on an exchange, just like a stock. So it’s easy to get in and out at the prices you want. In other words, they are highly liquid.
Furthermore, they are transparent. Since the ETF just tracks an index, you always know what stocks you own through the ETF. An actively managed mutual fund only discloses its holdings once every three months. Best of all, if you own a broad ETF, you are automatically diversified — and a diversified portfolio is your first line of defense against risk.
So how do you find the best cheap stocks to buy now through ETFs? Well, there are scores of ETFs specializing in value stocks. They automatically give you exposure to a wide range of cheap stocks to buy now — even if it might take a while for their true value to be recognized by the broader market.
A great example of this hidden-gem phenomenon are small-cap value stocks, which just happen to be the single best-performing asset class over long periods of time. If you’re looking for the best cheap stocks to buy now, you could do a lot worse than being patient with top ETFs like the iShares Russell 2000 Value Index Fund (IWN) or the Vanguard Small-Cap Value ETF (VBR).
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As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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