If you pay close attention to prices when you spend your money, you should be even more vigilant when investing it. 

When it comes to picking up a common, everyday item -- like a gallon of milk -- we may not be particularly price conscious. However, it stands to reason that expensive purchases are generally given more forethought. 

For example, few would splurge on a high-end digital camera without first doing their homework and evaluating the features, product specifications, and pricing of several different models. Likewise, a homeowner in need of a new refrigerator might spend an entire day visiting Sears, Best Buy, and a few other appliance retailers to compare prices before making a final decision. 

As a rule, we are all compelled to search for the lowest available prices. In fact, that fundamental driving force is what maintains economic efficiency and underpins our entire free-enterprise system. 

Curiously, our thought process is suddenly reversed when it comes to investing. The price of a stock usually plays second fiddle to other measures when an investor is choosing where to put his/her money. Considering an investment portfolio can often represent someone's largest single asset, this is clearly not the time to disregard prices. 

The Danger of Overpaying: 
When it comes to choosing stocks, valuation should always factor prominently into the final equation. However, many investors are simply too busy picking apart a firm's financial statements and looking for positive trends in sales, earnings, margins, and other performance measures. 

It's worth noting that great companies do not necessarily make great investments. The key to earning superior investment returns lies not in finding the most successful firms, but instead the most undervalued. 

Unfortunately, some people are so preoccupied with tracking a company's financial performance that they completely lose sight of how much they're paying for it. As the table below illustrates, this oversight can often lead to disastrous results.

The four companies above have been among the strongest performers in their respective peer groups over the past five years, delivering healthy growth rates and above average stock gains. After climbing steadily though, each saw its valuation (as measured by Price/Cash Flow) stretch well above historical norms, as well as the broader S&P 500 average -- which has been running in the low/mid teens in recent years. 

As such, each of these quality companies began the year with an impressive track record, but also an overextended valuation. Although these stocks may have looked dazzling on the showroom floor, their hefty price tags should have encouraged buyers to look elsewhere. However, those that put price as an afterthought and bought anyway have since suffered painful losses. 

Looking in the Wrong Place: 
At the end of the day, the whole point of investing is to eventually sell an asset at a higher price than we paid. Naturally, those who overpay for a stock today may find it difficult to receive an even higher price tomorrow. 

For some reason though, a penny-pinching shopper might drive across town to save a dime on a gallon of gas, but then invest thousands of dollars (the equivalent of a new plasma television) in a stock without ever considering the price.

And strange as it may seem, the same people who spend hours tracking down the best deal on a microwave or DVD player are often unwilling to spend more than a few minutes searching for underpriced stocks. 

There are several reasons to explain this behavior: 

• Some lack the time, training or expertise to accurately pin a fair-value estimate on a stock. Without this critical piece of information, there is no way of knowing whether the current share price is too high, too low, or just right. 
• Others assume that undervalued stocks must have deteriorating fundamentals or serious operating flaws. While this is true in some cases, many are proven industry leaders with solid long-term prospects. Volatile market swings can punish even the strongest of companies, so don't automatically assume that those trading at a discount are "damaged goods." 
• Still others mistakenly equate the value category with slow-moving stocks that offer little more upside potential than bonds. To be fair, undervalued companies are typically not as flashy as the next high-growth "story stock" or as exciting as the latest IPO. Nevertheless, that doesn't mean they can't make explosive upward moves -- just ask legendary value investors like Warren Buffett. 

Most often, investors simply believe that traditional ratios like price/earnings are the best method of spotting undervalued stocks. While these metrics can be helpful, they can also be misleading -- and they never tell the whole story. 

For example, is a company with a price of $20 and a P/E ratio of 16 a good buy? The answer is impossible to say with any certainty. 

To begin, earnings may not always be the best barometer of profitability, but even more transparent measures like operating cash flow have drawbacks as well. For one thing, most (but not all) ratios deal with static trailing figures and do not reflect future growth prospects. Furthermore, ratios typically fail to incorporate many critical factors needed to assess value, such as a company's cost of capital. Finally, they also commonly provide conflicting advice. For example, a firm's price/earnings figure could look very attractive, while another measure like price/cash flow might suggest that the exact same company is exorbitantly priced. 

Ultimately, the only way to determine whether $20 is a fair price for the stock mentioned above is to pinpoint the value of that stock.

If I said that the shares had a fair value of $40, then the gray area suddenly becomes crystal clear. The stock is selling at a wide 50% discount -- Buy!

Unfortunately, there are very few reliable sources for investors trying to obtain accurate fair-value estimates. However, for those who believe in buying their stocks on sale, we have a solution. -- StreetAuthority.com's Half-Priced Stocks newsletter.

Don't be Penny-Wise, Pound-Foolish: 
When it comes to managing your portfolio, there is absolutely no room for impulse stock purchases. 

Each month, a staff of analysts at our premium Half-Priced Stocks newsletter uses sophisticated discounted cash flow (DCF) modeling -- the same time-tested analytical tool wielded by many institutional money managers -- to crunch the numbers and find which companies have been tossed in Wall Street's bargain bin.

From an initial pool of thousands of companies in our coverage universe, our comprehensive DCF analysis narrows the field to those select few trading at steep discounts of 25%, 50%, and sometimes even more. 

However, cheap stocks can always get cheaper, which is why each newsletter recommendation must also undergo a rigorous fundamental analysis designed to pinpoint attractively positioned companies whose share prices are poised to converge with our fair-value estimates -- sooner rather than later. 

Earlier, we mentioned that superior investment results depend on finding the most undervalued companies, not the most successful ones. Our ultimate goal is to find both -- proven industry leaders temporarily trading well below their fair value. 

And for those that need "product reviews" to help in the decision making process, we also provide in-depth analysis and timely comments on many of the stocks we look at each month.

If you're the type that hates to overpay for anything, shouldn't that philosophy also extend to your investments? 

Thanks for reading!

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