3 Keys to Undervalued Stocks with Big Upside Potential

Low-priced stocks are the things that investment dreams are made of. We have all fantasized about buying a stock in the single digits and watching it soar higher.

Too often, however, investors never realize that dream.

For any number of reasons, investors often buy a low-priced stock only to sell it at an even lower price. This common practice is really quite curable.

The mistakes investors make when dealing with low-priced stocks have simple answers. Most of the time you already know what the answers are; it is the execution that is hard. I want to share some of these common problems and give you the solutions so that you can become a better investor.

Beware Buying the Bottom

Everyone wants to get something for nothing. If you can't do that, paying as little as possible is the next best alternative. I mean let's face it, who wouldn't want to buy at the 52-week low and then sell at the 52-week high?

The problem is that sometimes the bottom you see is not at all the bottom. Usually, stocks making new 52-week lows are not the stocks you should be buying. The market is telling you that this stock is consistently worth less and less when it appears on the list of the 52-week lows.

Bottom feeding is fine for some species, but investors that want to see good returns in a reasonable amount of time should avoid stocks at their "perceived" bottom. Always look for confirmation that the bottom is in and the stock is recovering.

Adjust Your Risk Profile

Buying a low-priced stock sometimes seems like a riskless or a very limited-risk venture. The stock is in the single digits and how much more can it go down? The answer to this one is always the same thing.

Any and every stock can go down 100% from where it closed the day before. Rarely does this happen, but the point is you have to think about returns more in percentages than stock prices. A $7 stock going to $3.50 is a loss of 50% and that is a hard-to-swallow number.

The solution to this problem is position sizing. You must know how much of your portfolio should be dedicated to low-price stocks and not put all your eggs in one basket. This is an issue that is unique to every investor, as everyone has a different amount of investable dollars, and most have a different time horizon as well. Proper position sizing will allow you to withstand short-term loss and also encourage long-term success.

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Zacks Investment Research

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Written By: Zacks Investment Research