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The New Rules

U.S. Stocks 2012: Five High-Value Stocks at Bargain Prices

Everyone likes getting a bargain, and investors are no exception – but finding cheap U.S. stocks that also offer huge profit potential is no easy task.

Picking stocks with low prices is not enough. Thanks to the market's May swoon and seven-for-eight losing streak earlier this month, there's no shortage of low-priced U.S. stocks in 2012. But many of those are destined to chug along forever with low prices – or go bust altogether.

At the same time, some U.S. stocks priced at $100-plus per share could be considered bargains.

The key in both cases, of course, is value.

Only by comparing a stock's price to its underlying value can you decide whether it's a "bargain."

Unfortunately, it's not quite as easy as it sounds. There are almost as many definitions of "value" as there are securities analysts.

However, most agree on the following fundamental measures of intrinsic worth:

  • The stock has a low price/earnings (P/E) ratio relative to other companies in its industry segment or the market as a whole.
  • The P/E ratio is below the stock's own average P/E over the past 10 years or so.
  • The company's earnings history is stable – i.e., the low P/E is not due to unusual capital gains or some other one-time revenue event.
  • The company's earnings have increased for the past three years on stable or rising cash flow.
  • The stock is selling at a price below book value – i.e., the company's tangible assets are worth more than the value of the outstanding common stock.
  • The company has little or no debt – and, if there is debt, it is rated "A" or better.
  • The current low stock price is not the result of a sharp drop in operating margins, management shake-ups or some kind of financial scandal.
  • In spite of its solid fundamentals, the stock price is lagging others in the same industry segment.

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The JPMorgan (NYSE: JPM) Losses: Here’s What Happened

Yesterday's announcement by JPMorgan Chase & Co. (NYSE: JPM) that it lost $2 billion on a "hedge" position is not only surprising, it's frightening.

I'll try and make this short and easy to understand, but the truth is that it's complicated. If we have a decent idea about what happened (and I do), it's bad. And if it's a tip-of-the-iceberg thing (which I don't believe it is), it could be really, really bad.

Investors put on hedges all the time. In fact, in our investment services like the Capital Wave Forecast we put on essentially the same type of "economic" hedges that JPM CEO Jamie Dimon is saying blew up on them. The economic hedges we put on are essentially hedges against long positions we hold.

For example, if I see some potential danger ahead, then I recommend we buy some protection, like buying the VIX in anticipation of rising volatility, or buying puts on broad market indexes.

The broad protective measures we take are economic hedges because they are not specific hedges designed to hedge potential loss in any one position. For example, if we owned JPM stock and we wanted to hedge our position, we might buy puts on JPM, or sell calls, or employ another specific hedge against our long position.

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