High-flying growth stocks have been the story of the 2023/2024 bull market. AI, the Magnificent Seven and chip stocks have dominated the headlines and boosted portfolios everywhere.
But chasing growth stocks isn’t the only way to make money in the stock market. In fact, for most of the last 100 years, finding bargain stocks has led to better performance.
Analysis by Wellington Management’s portfolio manager Sean Kammann found that, from 1927 to 2020, value stocks actually outperformed growth stocks by 397 basis points (just under 4%) annually on average.
One caveat, however, is that the last decade or so of (mostly) low interest rates has biased returns in favor of growth stocks, so if the Fed rate cuts are deeper and faster than expected and rates once again approach zero, value stocks may remain out of favor.
That said, many economists are expecting the fed funds rate to remain higher than it’s been in recent years and settle in around 3% over the longer term. (Current CME Group projections have rates in the 3.25 – 3.5% range at year-end 2025.)
So, if we’re looking at a sustained period of higher rates that may favor value stocks over growth, what are some ways to find bargain stocks that may once again outperform?
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3 Strategies to Find Bargain Stocks
The Net Current Asset Value Formula
There is no better analyst to turn to than Benjamin Graham, the father of value investing and the creator of the stock analyst profession. Mr. Graham created several investing methodologies, which are well documented in his most famous books: Security Analysis, co-authored with David Dodd in 1934, and the Intelligent Investor, which was first printed in 1949.
One of Benjamin Graham’s earliest analyses, created and tested 75 years ago, is the Net Current Asset Value (NCAV) approach. The objective of the NCAV formula is to find the minimum value a company would fetch if it was liquidated. The formula is:
Net Current Asset Value (NCAV) = cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities – preferred stock
The resulting value can then be divided by the number of common shares outstanding to find the NCAV per share. If the current stock price is less than the NCAV per share, the stock is a bargain.
Negative Enterprise Values
Identifying companies with negative enterprise values is another good way to find a bargain stock.
And it’s a little more straightforward than the Net Current Asset Value above.
Start with the market cap, then add debt and subtract cash. If the result is a negative enterprise value, you have a negative enterprise value stock.
In other words, if a company’s cash on hand is enough to retire all the debt outstanding and that leaves you with a cash balance that exceeds the market cap of the stock itself, you’ve got a bargain stock because it means the company is trading for less than it has in cash on hand.
It’d be a bit like buying a shoebox with $120 inside of it for $100. The value of the shoebox itself (the corporate structure) doesn’t really matter.
Our previous analysis of negative enterprise value stocks found that you’re better off avoiding financials and Chinese stocks as negative enterprise values aren’t indicative of cheap stocks in the financials sector and the risk of fraud in China is too great.
Using Price Multiples
The final way to find a bargain stock is one that most investors are going to be more familiar with, using price multiples.
Price multiples, such as the price-to-earnings (PE) ratio, the price-to-book value (PBV) ratio or the price-to-sales (PS) ratio, measure the price of a stock against another per-share value (earnings, sales, etc.).
Then, an investor can compare that ratio to other peer companies in the same industry and determine, relatively, which of those companies may be over or undervalued.
Because the PE ratio in particular has become a quick shorthand for whether a stock is “overpriced,” it’s important to note that not all price multiples are created equal.
You don’t want to use the same price multiple to compare apples and oranges. Using a company’s forward PE may be appropriate for tech stocks, but you don’t want to use that ratio for banks.
The link above has a full breakdown of which price multiples to use for which sectors.
With the possibility that value stocks may be regaining the favor of Wall Street, now’s a great time to learn a few ways to find bargain stocks. And if you’re looking for expert guidance, consider a subscription to Cabot Value Investor or Cabot Turnaround Letter to get you started.
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