Buying quality merchandise when it's on sale is a stock market strategy used by some of the greatest investors in the world - including Warren Buffett. After the volatility we've seen in 2020, there are signs that stocks like Kingfisher (LON:KGF) could fit that bill. But how can you tell?
The Kingfisher share price is currently at 154.9. But like many stocks, the uncertain economic outlook has made it difficult to forecast the future, and so valuations have been thrown into doubt.
Many investors will be keen to buy what seem like cheap stocks wherever they can find them - but this is a mistake. Instead, it's important know the different between a genuine bargain and a value trap - and often, the quality of the stock makes all the difference.
The good news is that Kingfisher scores well against some important financial and technical measures. It's a large-cap share with strong exposure to two very influential drivers of investment returns: high quality and a relatively cheap valuation.
To understand where that shows up, here's a closer look:
Quality stocks you can depend on
Good quality stocks are loved by the market because they're more likely to be solid, dependable businesses. Profitability is important, but so is the firm's financial strength. A track record of improving finances is essential.
One of the stand out quality metrics for Kingfisher is that it passes 7 of the 9 financial tests in the Piotroski F-Score. The F-Score is an world-class accounting-based checklist for finding stocks with an improving financial health trend. A good F-Score suggests that the stock has strong signs of quality.
Buying at a fair price
While quality is important, no-one wants to overpay for a stock, so an appealing valuation is vital too. With a weaker economy, earnings forecasts for all stocks are unclear. But there are some valuation measures that can help, and one of them is the Earnings Yield.
Earnings Yield compares a company's profit with its market valuation (worked out by dividing its operating profit by its enterprise value). It gives you a total value of the stock (including its cash and debt), which makes it easier to compare different stocks. As a percentage, the higher the Earnings Yield, the better value the share.
A rule of thumb for a reasonable Earnings Yield might be 5%, and the Earnings Yield for Kingfisher is currently 7.68%.
In summary, good quality and relatively cheap valuations are pointers to those stocks that are some of the most appealing to contrarian value investors. It's among these shares that genuine mis-pricing can be found. Once the market recognises that these quality firms are on sale, those prices often rebound.
Find the strongest shares in the stock market
Finding good quality stocks at attractive prices is a strategy used by some of the world's most successful investors. If you want to find more shares that meet these rules, you can see a comprehensive list on Stockopedia's StockRanks page.