The main goal behind the Stock Bargain Method is to add superiour value to your investments in the stock market. In a few simple words, this means supplying you with a stock investing system that reveals the most undervalued companies in the American markets. But it doesn’t stop there, there is even more value to it. The method is based upon the same criteria as in the well established system of Joel Greenblatt, “The magic formula” (ranking of good cheap stocks). The formula is fully explained in one of the best value investing books ever, “The little Book that (still) beats the Market”.
In other words, the companies that rank the highest are the ones with the best combination of highest earnings yield and highest return on capital. You can read more about the formula here: Joel Greenblatt formula
The Stock Bargain Method takes it one step further by filtering the companies that rank the highest even more. As a result, the method gives about a handful of new extreme stock bargains every month.
The Stock Bargain Method also works as your investment companion throughout the whole period that you are invested in a certain company that the model has recommended. It continually monitors all recommended stocks in the model, giving you the proper buy and sell signals, taking into account when a stock is most likely to continue its rise or fall.
Let me emphasize what I mean when writing “the most undervalued stocks”. To fully understand the meaning of undervalued stocks, we need to get into the principles of value investing. Read more about this here: The powerful principles of value investing
How does it work?
As mentioned above, the Stock Bargain Method is based upon the same criterias as in “The magic formula”. Based on the 30 companies that rank the highest, there are two more conditons that apply to the method, very important and efficient criterias to get qualified:
- The stock price must have a minimum of 50 % discount compared to its highest levels during the last three years (in other words, you pay no more than half of the highest price that the stock has achieved the last three years).
- The stock price must have a minimum of 20 % discount from a level where it already was recommended as a bargain in “The magic formula” during the last six months.
Why are these criterias necessary? Well, it probably isn’t that hard to see the advantages. At least, it says quite a lot about the potentials in the market pricing of a company’s shares, since history shows us that stock prices have a tendency to get back to earlier price levels at some point. And, since the model is based upon companies that already qualify as undervalued, this tells us furthermore:
- The companies that fulfill both of the above mentioned criterias are extremely undervalued.
- These stocks have sufficient volatility (price movement) to achieve high profit and returns.
However, there is one exception from using the above mentioned criterias: Growth stocks! If a share price in a company has more than doubled through the last three years, it qualifies under the Stock Bargain Method when it breaks through the highest level during the last three years. This is because it is very likely that the share price will continue its rise and establish new and higher price levels (which is already proven by having doubled). PS: This applies only for companies that already qualify as undervalued by being among the 30 cheapest stocks (as described above).
By using The Stock Bargain Method you have now identified the extreme bargain stocks with a huge price potential. But..
If I buy, how will I know that the shares just won’t continue their fall..?
This is quite likely to ask, since the companies’ share prices have fallen very much related to their earlier performances. It is also a common fact that shares who have fallen a lot, have a tendency to continue their fall, or at least stay in a very low range for a period of time. And may use quite some time before they start to rise significantly again. So, how to avoid investing in a share that just will continue its fall?
- A certain increase must be seen in the stock price before the model recommends a “Buy”. It must be significant enough so that it is more likely that it will continue to rise instead of falling. This means there is a high probability that the fall has ended and that the share price is on its way back to earlier levels. An increase is considered significant when the price has gone up by 4 ATR (Average True Range, an indicator of volatility, how much a share price moves from one day to another, read definition here). Four ATR is chosen in consideration of keeping a stock for several months, and allowing it to move widely. It is not a trading signal, it is just a proper level to buy. Choosing for example only a rise of 2 ATR before buying may result in the price turning down again to continue its fall (which may happen anyway, but by using 4 ATR instead, the increase is more significant and it is more likely that the big fall has ended and that the turn-up will last)
- It is important to be patient enough to let the share price reach a 4 ATR increase before you buy. This is because until it has risen that much, it may try to peak upwards again several times before it has ended its final and deep fall. In other words, to predict the turning point of a stock price is impossible, therefore it will benefit you to wait until a certain rise is established. Remember, this will in many cases allow you to buy a company at very low prices, because it may continue its fall before you buy.
When to sell?
The model recommends a minimum of 50 % rise in the share price before you sell it. This is quite a significant increase, but at the same time it is also quite likely that the stock will reach this level, given the criterias mentioned above. When the price has reached a 50 % gain, you just let it continue its peak upwards as long as it lasts. Specifically, this means you keep the stock until it loses 1/4 (25 %) of its gain. This is explained by an example below:
- Example 1: Let’s say you bought a stock at $100. When the price reaches 150 (50 % gain) you start to monitor the price on a daily basis. It reaches its highest level (end-day price) at 160 before it suddenly peaks down again. $160 (highest price) minus $100 (your buying price) is $60 (your maximum gain). 1/4 of $60 is $15. This means that you sell the shares when the stock price passes $145 ($160-$15). Let’s say the end-day price is $144. Then you sell it the following day at market price, for example at $143. Your gain is at the end 43 %.
Why should you be willing to lose so much of your gain (from 60 % to 43 %)? This has a very clear purpose: To allow the stock price to move in a wide area on its way upwards. Another example explains this:
- Example 2: Using the same example as above, the price peaks down from its highest level at $160. You are willing to sell at $145 (1/4 of your potential gain is then lost). But this time the stock price turns up again after having ended at $147. It moves up to $160 once more, but then turns down again, now to $146. In the following weeks it moves between $150 and $160, almost no movement at all. Then, after two months, the stock gets a positive momentum and peaks upwards, until it reaches a top at $200. You bought it at $100. This gives you a potential gain of $100 (100 % gain). 1/4 of $100 is $25. $200 minus $25 is $175. When the price passes $175 on its way back down, you sell it the day after, for example at 173. Your gain is then 73 %.
The example above shows the importance of using quite a wide range in your gain-keeping. Even if you had sold the shares at $160 (its highest level for a while) you would not take part in its following rise, and your gain would have been 60 % (or probably less) instead of 73 % that you actually achieved.
It might as well happen that the share price does not reach its gain of 50 % at all. Then it is important to reduce your losses to a minimum. At the same time, as shown above, it is also important to let the stock have enough space/range to move and develop. The Stock Bargain Method uses a loss of 25 % as a limit for selling. Losses that exceed 25 % are not considered beneficial to keep. And this is why:
- Stocks that have such big losses tend to continue their way downwards. Many times it seems that they use a long time to recover and get back to their earlier levels. Taking in consideration that a stock is held for not more than one year, it is not recommended to keep it with a loss more than 25 %.
- The American markets consist of more than 3000 registered companies. This tells us that most likely there are constantly big bargain stock opportunities out there, probably quite a few.. And you should go hunting for the best performing stocks, right? Keeping a loser (a stock with big losses) just gets too expensive related to the alternative (alternative cost), which means putting your money in a winner instead. In other words, the difference between what you lose and what you could have gained on a winner, just gets too big…
- Keeping your investment capital is essencial. If you don’t keep control of your losses, they might eat a huge bite of your capital, hard earned money that was supposed to grow instead of decrease…
- It is also a psycological aspect to this: Keeping a loser (a stock that continues to peak downwards) might be a challenge for your mindset. Mentally it is quite hard to see a stock just continue to lose its value, knowing your money do as well.
Stick to the simple, specific rules!
As you may have noticed, the Stock Bargain Method gives you a specific set of rules to follow. There are certain advantages related to that:
- It is always much easier to follow a system with pre-defined rules. Then it is easier to control your emotions too, either you have a big potential winner or loser. In addition, it will help you avoid being affected by distractions (news, others opinions etc.).
- To succeed using an investing system/model, it is required that you are consequent. And it is a lot easier to be consequent when you have a pre-defined set of specific rules (they guide you and make the decisions for you).
The rules of action mentioned above are designed this way because:
- You should not forget that your basis for investing in companies picked by the Stock Bargain Method is that they are considered to be bargain stocks (extremely undervalued companies showing strong financial numbers). This means that they have a great potential (+50%).
- The fluctuations in the share prices are basically not interesting at all for you as an investor (and not a speculator), because you own shares in a company because of its underlying values. Given this fact, the stock price is allowed to move in a wide range (from minus 25 % to plus 50 %, 75 % totally) before any action is required from you. This allows the market to work for you, if you allow the market to do so by giving it time and space to develop. As a result, it is very likely that at some point the market will consider the value of your stocks in accordance to its underlying values. Maybe even higher…
- The Stock Bargain Method helps you to have a good grip on your investments. It helps you to keep control. It helps you to keep your wins and secure your gains. It helps you to limit your losses before they eat too much of your precious investment capital.
Keep in mind these important words by the father of value investing, Benjamin Graham (from his bestselling book “The Intellingent Investor”):
- “The most realistic division between an investor and a speculator lies in the attitude towards the fluctuations of the stock market. A speculator’s highest purpose is to predict and to profit on the fluctuations in the market. The investor’s highest purpose is to buy and keep suitable stocks to proper prices.”
- This is NOT a software program or system that automatically generates results, it is a model developed for manual use. Think of it as an Excel spreadsheet where you type in the necessary criteria, and by use of pre-defined formulas Excel provides you with helpful results.
- According to sound investment principles, the Stock Bargain Method highly recommends investing in at least 8-12 different companies at the same time. This will reduce your risk of losing a big amount of your total investment capital on one stock. You should be aware that the model also will have many losers, which means it is important to have a portfolio with a sufficient number of companies to let you get the big winners too. To get started, a practical advice is to make one new investment every month the first year, or for example buy two-three new stocks every third month the first year, ending up with your desired amount of stocks after 12 months.
- The Stock Bargain Method picks companies divided in two categories, the first with a minimum market value of 333 mill. USD, and the second with a minimum of 12.000 mill. USD. PS: These are the values before the additional 20 % discount in market price that must be seen before a company is chosen by the model. The reason that there are two categories, is that you as an investor can have the choice to pick between the best mid-cap or large-cap companies.
- The Stock Bargain Method has not been tested back in time except of the author’s own investments using the same criterias. It is not developed for the purpose of back-testing, since it is a value investing principle model (based on underlying values), and not a system based on historical prices. Back testing is regarded interesting but of no value, because that approach will not be valid for value investing principles.