Many investors love to buy cheap stocks, but as Mr O’Neil (investors.com) puts it: “Stocks are cheap for a reason”. In many (but not ALL) cases, investors do not realize that the stocks they bought cheaply belongs to a company mired in problems with slowing earnings, sales growth and shrinking market share. These are bad traits for a stock to have, regardless of how cheap it is.

Nonetheless, although most investors have lost money buying cheap stocks, there are still many savvy investors (read: Warren Buffett) who have made fortunes buying cheap BUT GOOD stocks. How did they do it? Below are some guidelines:

Buy a business, not a stock.

When evaluating a stock, see yourself as a business owner, not a stock investor. Only buy businesses that you understand. When you understand a business, you will be able to evaluate important questions like: Is the company’s stock cheap because it is losing market share? What are the challenges faced by the company?

Buy stocks in companies that have a proven track record.

This includes a consistently good EPS, sales, equity and free cash flow growth rate and a long history of great ROIC (above 10% for the last 10 years).

Buy stocks that have a big MOAT

A moat is a ‘protective shield’ that a company has that prevents other companies from invading their territory. Examples of moats include

• Brand name: The company has a very strong brand name, making it difficult for other companies to compete with them. An excellent example is “Apple”, with its group of die-hard fans.
• Secret: The company has a patent or trade secret that makes competition illegal or very difficult. Example: 3M.

Buy stocks with a good and honest management

Traits of honest management include admitting their mistakes (if the company did not do well for one quarter, they should admit it and explain how they intend to improve the situation) and accepting a reasonable compensation for their work.

How to buy Cheap Stocks?

At this point, you may be wondering: If a company has such an excellent track record and characteristics, why is the stock cheap?

Most of the time, these companies stocks are cheap because of a temporary problem (such as missing EPS estimate) or because the overall market is bearish. At times like this, you can normally buy the stocks cheaply, preferable at a 50% discount.

As long as one does his/her research diligently and is willing to wait patiently for a good price, he/she can definitely join the ranks of successful investors. A bear market (which is NOW) presents the best buying opportunities.

Trading in the Stock Market involves risk, but if you know what you are doing you stand the chance of making a lot of money.

If you have not thought before of what trading is then the best analogy to consider is that trading is a bit like operating a small business. You have to commit your money to a particular opportunity when you start a business and you use your knowledge and skills in assessing the chance that a chosen business opportunity will prove profitable.

A business will possibly fail and many do, but the research you do in advance should make you confident that you will make money. Sometimes you will lose money, but if you are good you will make more profit than losses. Trading is in this way just like planning to start a business, and if you are wise it will be your knowledge and research that will improve the odds for you over the next man.

To be a successful trader running a day trading system, you need to work to understand the market in your area of expertise. Don’t be fooled into thinking that being a trader is easy and that money will fall into your bank account. Just like anything else you need to develop your own market appreciation as a skill and apply that skill to make money.

Traders can and do make money on in an up or down market, and the best of them use their own technically based analysis as well applying fundamental principles of the stock market to make their profits. Traders of stocks have many and varied approaches to how they invest in the market. Some buyers love the gambling aspect and like to take large gambles when they invest.

They choose the most risky stocks and have to accept substantial losses as well as enjoying the equally high gains. Others prefer to look for safer opportunities. Both approaches are equally acceptable under certain circumstances, and it is, of course, the long term profitability over many trades that matters. Investors are slightly different from traders, and investors put their money into stocks over a longer period and they also get dividend as a reward for investing at the end of every financial year. Sometimes companies also offer premium shares to longer term investors as existing share holders, as a bonus. However, although this is not seen as risky as short term trading in the stock market, investing can also be a dangerous, yet profitable endeavor.

Many people have been burnt and decide not to ever invest or trade again, while others thrive and prosper. The main thing to realize before anyone starts trading is that although it may appear easy, there is a lot of knowledge and skill in profitable trading. So, don’t make the mistake of thinking that you can just expect to make money without first developing knowledge and experience, or accessing the knowledge of others within a stock trading system that you trust.