Seabhaid Racing

There are three tests to subject a stock to when you're looking to invest in "value" or cheaply priced companies - as you should. The stock should have (1) low Price to Earnings (P/E), (2) low Price to Book (P/B), and (3) low Price to Cash Flow (P/CF). Sticking with these criteria can reward you with eye-opening gains over the medium- to long-term.

Here are the ratios that I've been using successfully for more than a decade to uncover the best value companies:

1. Low Price to Earnings (P/E): Select only those companies with total shares that are worth less than 10 times their earnings or profits.

2. Low Price to Book (P/B): 3 is my cut-off. But when a company's total share value is less than twice its net asset value (book value), I get excited.

3. Low Price to Cash Flow (P/CF): Price shouldn't be more than 10 times cash flow. Remember, cash is the real deal. Net income isn't.

If a company passes all three of the above tests, you have a company worth looking into. If you see that it's bringing in more and more customers at low cost, you probably have a winner on your hands.

Buying Value Is as Easy as 1, 2, 3

Squeezing higher returns from the stock market to make your portfolio hum is surprisingly easy when you buy value stocks.

David Dreman, in his book Contrarian Investment Strategies: The Next Generation, investigates four ways to buy low. Look for:

1. Low Price to Earnings (P/E)
2. Low Price to Book (P/B)
3. Low Price to Cash Flow (P/CF)
4. Low Price to Dividend

I don't even use that last criterion when I look at stocks, and neither should you. Mr. Dreman concurs, saying it's the least effective of the four strategies - although all four individually beat the market index with ease.

To make best use of the above numbers, invest in a stock only if the first three (P/E, P/B, and P/CF) all show low ratios. If you do only this, without any further research or work, you'll come out ahead of the market.

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