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If you can’t explain in concrete terms why a stock is a bargain, it probably isn’t one. Investors who just look at the percentage decline in the stock’s price aren’t asking the big question: What is this stock

worth—not what was it selling for in a hyper-bull market?

You answer that question by doing your homework and thor- oughly analyzing the business behind the stock. Ultimately, the soundness of the business creates the perception of value in the stock.

C a u t i o n

A stock that has fallen by 75 percent is not necessarily a bargain. Some stocks do fall to virtually zero in value. If you don’t believe this can hap- pen, ask some of the folks holding stock in the “dot.bombs.”

LOOK FOR SIGNS

Bears sometimes attack the whole market and other times individual sec- tors. The demise of the longest bull market in history began in April 2000, when bears began their sustained attack on Internet/technology stocks. Like most bears, this one threw off confusing signals. Beleaguered investors saw every brief rally on the way down as a sign that a firm bot- tom was in place. Unfortunately, it wasn’t.

When a sector is under attack, few stocks escape. Everything suffers, whether it was really bear food or not. The whole sector may be under at- tack, but you are interested in one or a small group of stocks you think are ultimately sound. Stocks in a sector can ride a bull up with the same ease that they rode the bear down.

XYZ is a great company with innovative products and a potential market leader in its sector at some time in the future. Right now, its stock is enjoying a dizzying ride upon the back of a bull. Watch XYZ’s funda- mentals on the way down. Are analysts cutting back on earnings projec- tions? Has the company missed any earnings estimates? After you do your research, you believe XYZ is worth about $20 per share, even though it currently trades at $50 per share.

C a u t i o n

You can be your own worst advisor. You convince yourself a stock is going nowhere but up, so you buy at any price. When it starts to fall, you tell yourself it will surely rebound. When it doesn’t rebound, you sell at the bottom. Don’t feel bad—professionals do the same thing sometimes.

The mistake many investors make is to buy the stock on the way up and sell when it has lost most of its value. If you stick to your analysis, the

stock isn’t a buy candidate until it reaches the approximate dollar figure it is worth. Don’t be dismayed if the stock falls even past the price you set as reasonable. There’s nothing reasonable about a bear market.

TROUBLE BY ASSOCIATION

Sometimes the only thing wrong with a stock is the company it keeps. This is especially true when bears are ravaging a market sector. If it even smells like the sector, the stock may come under attack.

A sound company that has its stock beaten up because it is in the wrong sector is an excellent candidate for bargain hunters. When the mar- ket begins its upturn, this company is likely to draw much attention from investors looking for a solid buy.

DON’T GIVE YOUR HEART AWAY

Bears love lovers of particular stocks. They know if you fall in love with a stock, you will pay an outrageous price and then hold on until the stock has betrayed you a dozen times and trades at 10 percent of what you paid. You will sell in disgust, and the bear wins again.

Always make the stock come to your price. If it doesn’t, move on to something else. There are well over 8,000 individual stocks; surely one of them will catch your eye.

STAYING POWER

The bursting Internet/tech stock bubble taught many investors that just because a company can raise hundreds of millions of dollars doesn’t guar- antee it will be around in three months. However, there are many companies—some old, some new—that dominate their markets in a way that assures continuance for at least the immediate future.

Microsoft, whether you love it or hate it, isn’t going anywhere soon. Microsoft software is in 95 percent of the personal computers in the world, and it will stay there until something cataclysmic happens. Will Microsoft stock return to its previous levels during the raging bull mar- ket? What is a reasonable price for the stock? After the 2000–2001 melt- down, the market may have fairly priced the stock for the first time in years.

Make the buy decision based on the fundamentals of the business and what you expect from the stock. A bear market can take the hype out of a stock’s price and make it a good buy.

NOTHING LASTS FOREVER

The last section notwithstanding, just because a company has been dom- inant in the past is no guarantee it will remain so in the future. U.S. Steel was once a symbol of America’s industrial prowess. Montgomery Ward was a retailing powerhouse. Apple Computer held the personal com- puter market in its hand and let it slip away.

The list goes on and on. Once proud leaders—dissolved, bankrupt, or buried by competitors—remind us that companies that fail to evolve and adapt to change are fodder for the scrap heap.

Blue-chip stocks are not immune to bear attacks, and past glories mean nothing to today’s investors. It isn’t hard to spot companies cling- ing to outdated business models and pre-Internet strategies. The business press does a good job of pointing out these companies to the public.

A ROSE BY ANY OTHER NAME

In addition to studying a company’s fundamentals and market position, you need to anticipate how other investors will view the stock during a rising market. A stock’s price is driven up or down by investor demand. If there are more sellers than buyers, the stock’s price will fall no matter what the fundamentals look like.

Fundamentals may influence investor demand, but emotions can be even more powerful. The truth of that statement is borne out by the recently burst Internet/tech stock bubble, where fundamentals were nonexistent or ignored. The same emotions that inflated the bubble punctured it. Will other investors see the same rose among the thorns you see? If not, the stock isn’t going anywhere.

WHAT DO THE ANALYSTS SAY?

Stock analysts for major investment companies follow stocks and report on them. One of their key tools is estimating future earnings.

Much of this information is available free on the Internet at such sites as Morningstar.com and MSN MoneyCentral.com. Major compa- nies may have a significant number of analysts studying the company and making projections. Projections are very subjective because they call for an interpretation of future events. It’s common for two analysts to have very different views on the same company.

One way you can tell if a stock could drop further is to look at the earnings projections from different analysts. If you see a big gap in the es- timates, it’s a sure sign the stock has not finished its drop in a bear mar- ket. Analysts also issue recommendations about whether investors should buy, hold, or sell a stock. There are variations, but the idea is that a stock that analysts move from “buy” to “hold” is going to drop.

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The Internet has done wonders to level the playing field for small indi- vidual investors, but it’s just a matter of following the money to realize that big institutional investors and wealthy individual investors still get the best information first.

If more analysts are rating a stock a “buy” than one month ago, you can also expect a price increase. Likewise, if more analysts are downgrading from a “buy” to a “hold,” expect further price drops.

DEAD-CAT BOUNCE

A “dead-cat bounce” is one of the false signals bears leave. (Please, no angry letters from cat lovers—I don’t write the news, I just report it.) This indelicately phrased phenomenon occurs when a stock has fallen from a dizzying height, hits bottom, and briefly rallies.

True believers in the stock will see this as a sign of a return to new heights. Unfortunately, what happens next is not a rally but a continued slide into the dumps. “Dead-cat” stock doesn’t rebound or stage a sus- tained rally. If you’re in love with one of these unfortunate stocks, your hopes for a life together are shattered.

A COMPANY IS NOT ITS STOCK

One company’s stock sells for $125 per share, while another company’s stock sells for $15 per share. If you asked a group of nonprofessional in- vestors which company was better, many would pick the $125 per share company. As consumers from birth, we learn that an item’s quality relates directly to its price. High-priced items are high-quality items.

But the Internet/tech stock collapse in the spring of 2000 proved that the quality of a company doesn’t directly drive the stock’s price. A company’s fundamentals certainly influence investors, but the price of a stock is ultimately set in the market where many other forces come to bear (there’s that pun again).

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A company’s stock price may or may not be an accurate reflection of the company’s value. Stock prices move based on expectations of future events and whether more investors are positive or negative in those ex- pectations.

Bulls are as indiscriminate as bears. When the market is super-heated, as it was in the late 1990s, you find stocks trading in triple digits that weren’t worth a single-digit price. Internet/tech companies believed they had to grow very fast to survive and burned through cash like there was no tomorrow—and for many, there wasn’t.

Don’t confuse a company with its stock price. Bad companies can have very high-priced stock, and good companies can have lower-priced stock. When the bubble bursts and the market clears its collective head, companies with good fundamentals will be popular again. Investors still smarting from high-priced failure will look for solid investments when the market begins a recovery.

PROTECTING YOURSELF

As noted earlier, bears are notorious for sending out false signals. Stocks may rally in what appears to be the end of a bear market, only to fall back even further.

If you think you’ve found a real bargain, keep the bears from turn- ing around and biting you by using limit sell orders. These orders become market orders if the stock’s price falls back to a certain price.

This way of protecting yourself from a stock retreating after a rally works best for stocks you’re not interested in holding for a long time, since a volatile stock may drop back far enough to trip the limit sell order.

SHORT-TERM PROFITS

While this borders on speculation, there’s no reason not to take advantage of a relatively quick profit when you see one.

The stock market is self-correcting which is why there are bull markets and bear markets. Bears often overcorrect the market, espe- cially for stocks not particularly overpriced in the beginning. These are times for profits.

Just because the market has underpriced a stock doesn’t mean you should buy and hold it in your portfolio. As I emphasized in our previous discussions on asset allocation, any asset you buy should fulfill a purpose in your portfolio.

Reaching for quick profits can be risky, so don’t use your retire- ment money for this purpose. You should also be aware of the tax con- sequences of quick profits. However, when framed the right way, a quick profit is a way to raise more cash for those securities you want to hold.

DON’T LOOK FOR THE BOTTOM

It doesn’t make any sense to wait for the bottom of the market, because you won’t see it until it has passed. Focus instead on a reasonable price for the stock: Where do you expect the stock to go?

Bottom feeders seldom find the bottom. They’re just like the folks who want to sell at the absolute peak. Buy when the stock hits a price sup- ported by the fundamentals of the business. Sell when you have made your profit target, or not at all if that is your strategy.