So, when are stocks on sale?

The following is a guest post from Rob L., a fan of My Own Advisor living in Munich, Germany.

Probably one of the hardest things for an investor to determine is when a stock might be on sale.  Today, I want to share three methods investors could use to help determine that.

#1 – Value Investing

Best known as “Graham Investing”, you can find out-of-favour stocks (hence undervalued stocks) by looking at such things as P/E ratios and book value.  While you may find bargains eventually, it is hard work and I suspect that most investors don’t have the time or the interest to do that.  If you’re really interested though I know there are MBA courses on it. Let’s move on to #2, something less sophisticated.

#2 – Beating the TSX

For Canadian dividend investors this is in my opinion one of the methods for scouting undervalued stocks. You may have heard of “Dogs of the Dow”, a rather simple method using dividend yield to identify undervalued U.S. stocks? Well, “Beating the TSX” is its northern cousin; the same principle applied to the TSX.  David Stanley has used this approach for years, decades in fact, with great success.  Some more details about David’s approach appear in a September 2012 Canadian MoneySaver article here.

#3 – Re-balancing

This is probably one method that is most applicable to the “average” investor and to those of us who want to hold U.S. and/or international index funds for diversification.  Both Garth Turner (Greater Fool) and Andrew Hallam (Millionaire Teacher) have referenced this approach a few times.  I’ll try and do it justice here.  The reason this method works?  It’s easy to understand and apply.  First of all, you should have at least three main parts in your portfolio:  a bond, some domestic equity and some U.S. or international equity.  Maybe these parts are in similar portions, say 33% allocated to each part.  Next, using this simple mix of index funds, when you have extra capital to invest, just put your focus on purchasing the index fund that is the cheapest at the time.  Let’s call this, buying the lagging index fund or ETF.  For example my current allocation is 60/40 stocks to bonds.  (I actually have no international holdings at the moment but stay with me).  With a surging equity market this year, my allocation has recently shifted to 65/35 stock to bonds; so this tells me I should probably invest in bonds to get my allocation back in line.  I don’t need to figure out if stocks are a good deal or not, clearly my asset allocation tells me it’s time to buy bonds (and avoid buying stocks that have appreciated in price).   Still confused?  Andrew Hallam wrote a great article on exactly how this works so I highly recommend taking 10 minutes to read it here.

As you might be able to tell I’m a fan of keeping things simple so I favour #3 but surely there are many other ways to find out if stocks are on sale.  Maybe you can tell me your tip?  Does My Own Advisor have any tricks?  How do you figure out when stocks are on sale?

Rob L. is a fan of My Own Advisor living in Munich, Germany.  Rob is passionate about investing and is currently working through his own plan for financial freedom, about 10 years away.