Undervalued shares recognized with dividend yield

Oscar Wilde described a cynic as a man who knows the price of everything and the value of nothing. Alas, the same description applies to many investors. Recognizing true value and being able to identify quality are two of the greatest forces investors can have behind them in the stock market.

How to Identify Quality

There are many ways of measuring the quality of a share, but the most persuasive characteristic of all is a company’s standing as a blue-chip operation.

To save time and turmoil, to pave the way to profits and, most of all, to minimize risk, the dividend-yield theory should be applied only to the most prosperous and progressive corporations on the stock exchanges — the blue chips.

Why concentrate on blue-chip stocks when searching for quality? Don’t some young, growing companies have high-quality characteristics and potential for paying outstanding dividends? Aren’t there good values to be found in formerly troubled, turnaround companies under new and better management?

Perhaps. Sometimes the company on the brink of disaster does save itself. Small companies do sometimes break clear from the pack and achieve spectacular success.



But with such companies, risk too runs high. There is no way to be certain they will achieve their goals. Talk comes easy; evidence is harder to produce. A lot of young companies in growing industries have not been able to survive the competition. Even a chief executive with a brilliant record may not be able to pull a sinking ship out of deep, dark waters.

The world of blue-chip stocks offers fewer unpleasant surprises. These companies are managed by the best, the most experienced leaders that money can buy. Their products and services are well known and widely distributed. They often are sold on international markets, especially in the lesser-developed countries, where growth potentials still are extraordinary. Blue-chip companies have the most sophisticated research centers, the most elaborate advertising programs, the largest sales organizations and the longest histories of profitable progress.

They are the most willing to share profits with their stockholders, paying dividends that can help investors keep pace with inflation and provide a safety net under the prices of stocks.

Secondly, understanding the cycles of blue chips will help you be positioned at the right place in the market at the right time. Blue-chip shares are generally in the forefront of every major market move. They are among the first stocks to rise in a bull market and nearly the last to fall when the market declines.

In good times, blue-chip companies outperform both their lesser competitors and the economy. In bad times, they resist adversity best. Time and time again, experience has shown, there is no profitable substitute for quality.

What is a blue chip?

Clearly, though, not every share that goes up is a blue-chip stock. To some investors, any share they own is a blue chip!

Confusion over the definition of blue chip in the stock market abounds. Maybe it is the term itself that gets our thinking off track. Originally, the expression comes from the blue chips used in a poker game. The blue chips are the highest denomination of money. They are the most expensive tokens — the most valuable chips in the game.

In the stock market, however, price has little to do with value, and even less to do with the definition of a blue-chip stock. Only as it relates to the dividend, to earnings, or to book value is price an important measure of blue-chip quality.

The term really refers to the quality of the company on which the stock is issued. A blue-chip company is one that has a long history of corporate excellence.

How to Identify Value

But recognizing quality is not enough to guarantee profits in the stock market. Even a top-quality share can be overpriced.

Without conscious effort, we automatically measure relationships of price and value every day of our lives. It doesn’t take a genius to realize that Rs. 1,000/- is an undervalued price for a new car, but an overvalued price for an umbrella.

Once you have identified a high-quality blue-chip share, investors should apply the measures of good value. In this way, both safety of capital and total return are maximized.

If concern about value persists, it makes sense to buy stocks as if buying a company itself — as close to its net asset value (book value) as possible.

Thus, the linking of quality and value in the stock market can help investors select timely — and undervalued — stocks. Close attention to fundamental investment precepts may not be the most glamorous approach to equity investing, but it is the safest and most sane way to ensure long-term investment success.