Buying Stocks at a Discount Price in Volatile Markets
Andrew Leckey

The volatile stock market provides opportunity for investors.

Buying a stock at a discounted price only makes sense, however, if you've snared a bargain that actually pays off in the long run. That is easier said than done.

"We've seen a wipeout of stock prices across market segments with a 'sell now and ask questions later' mentality," said Dave Donabedian, chief investment officer with Atlantic Trust Private Wealth Management. "But it's not as simple as looking for the stocks that have gone down the most."

Fundamentals of a company and its industry remain crucial when shopping among downtrodden stocks, he said, with price history being only one part of the equation. Calm down and keep current market volatility in perspective.

"While volatility is high, it is not extremely high," said Steve Horan, head of private wealth for the nonprofit CFA Institute in Charlottesville, Va. "It was more volatile in the real estate crisis in fall 2008, in the first Greek bailout in May 2010 and during the debt standoff in early August 2011."

The CBOE Market Volatility Index, or VIX, measures the market's expectation for future swings in the Standard & Poor's 500 stock index. It is often called the "fear index."

"The VIX, which historically averages about 20, has lately been at around 30," explained Horan. "During those three other events, however, it hopped up to as high as 80 and was often at 40."

Whenever the economy improves, stock price revivals won't take place across the board.

"This is very different from March 2009 when you could have thrown a dart at the market and made money because there was almost no way to be wrong," believes Tom Jacobs, lead advisor with Motley Fool Special Ops, a special situations value service in Marfa, Texas. "Now you have to be selective and can't simply buy the market."

When admiring big stock names, remember that you won't make significant money on them unless you pay a really cheap price, Jacobs cautioned.

The shares of youth retailer Aeropostale Inc. (ARO) are down by more than one-half this year on weaker sales stemming from merchandise, inventory and branding problems. Some experts see the current price as attractive not only because the retailer can come back but also because the price is so low that there's potential for a leveraged buyout.

"While Aeropostale stock has been hammered and hammered, people don't realize that teens aren't going to stop buying clothes," said Jacobs. "At its current price, Aeropostale is almost 'vulture food,' and, if a buyout does occur, it will be for twice what the stock is trading for now."

Cisco Systems Inc. (CSCO) shares declined this year as the world's leading supplier of data networking equipment and software faces a weak economy and has increased competition in several product categories. Yet the demand for routers and other equipment will continue to grow in our increasingly interactive society.

"Cisco stock is really cheap for a company with a lot of cash that can pay out dividends and do stock repurchases," explained Jacobs. "The downside is so low that it is like you're getting the upside for free."

Target Corp. (TGT), one of North America's largest retailers, has seen its shares decline this year due to sluggish consumer spending and persistent economic worries. The company's aggressive expansion in the food business will lower returns somewhat but should increase the number of shoppers for its other merchandise. It is also entering Canada.

"Target had a rough first half of the year with sluggish same-store sales, but now results have picked up," said Donabedian. "This is an attractively valued stock with an above-average dividend yield."

Johnson & Johnson (JNJ), whose stock isn't down but is nonetheless historically low, has had to deal with product recalls and not having some new drugs approved by regulators. Yet it is still the world's largest, most diverse health-care company.

"Johnson & Johnson stock is never this cheap, but for months now it has made it possible for you to get low risk and low price in a stock without having to get fancy," said Jacobs. "The company puts out billions of dollars in free cash flow that can be used to repurchase shares and pay a strong dividend."

Besides companies under extreme pressure, there are high-quality firms whose shares are lower mostly as a byproduct of all the mayhem that's been going on around them.

For example, it might seem surprising that Donabedian and Jacobs consider Apple Inc. (AAPL) to be underpriced based on its market leadership, heavy cash load and global growth potential. In addition, Donabedian believes the stock of McDonald's Corp. (MCD) and Nike Inc. (NKE) are bargains right now.

Banking has been one of the hardest-hit sectors in the market downturn, with stocks such as Bank of America (BAC), JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) down dramatically this year. Of course, investing in them requires having some confidence in both management and regulators.

"These banking stocks are priced to fail, but if you think they won't, they are names worth looking into," concluded Jacobs. "Does anyone really believe that Bank of America isn't going to be trading higher in the next 10 years?"