Stock picking can be hard at the best of times, but spotting an undervalued stock is particularly difficult when the market is booming and valuations are topping out.
So, what's the best way to find the next Afterpay Touch Group Ltd (ASX: APT) and just as importantly, at the right price?
1. Cash flow is king
While there are plenty of shares that aren't performing well in 2019, the difference between the likes of Syrah Resources Ltd (ASX: SYR) and National Storage REIT (ASX: NSR) is cash flow.
Many of the ASX Resources shares have been beaten down or are underperforming in 2019 – for example, the Syrah share price has plummeted more than 60% this year, as it has struggled to boost its earnings.
Meanwhile, the National Storage REIT security price is up just 1.42%, but has been consistently paying out its cash flow to investors in the form of dividends.
All in all, strong cash flow can continue to satisfy shareholders in the form of dividends, even when capital growth is hard to come by.
2. Strong growth prospects are important
While the Seven West Media Ltd (ASX: SWM) share price is down 13.21% so far this year, I personally wouldn't be looking to buy in 2020.
One of the big factors is that I don't believe in the long-term growth of print media, to which Seven West has significant exposure.
On the other hand, the likes of NEXTDC Ltd (ASX: NXT) is a leader in the data management sector and continues to be a fast-growing ASX tech stock.
By picking an ASX stock with strong upside potential in the future, it's easier to hold onto it when the times get tough than it is when staring down the barrel of industry headwinds.
3. Countercyclical stocks can weather the storm
As important as future growth prospects are, the downside protection that is offered by countercyclical stocks can be invaluable for your portfolio diversification. A countercyclical stock is one that tends to maintain value and provide regular income when the economy is slowing down or staying flat.
For example, while the AGL Energy Ltd (ASX: AGL) share price is down 6.35% so far this year, earnings of companies in the Energy sector have historically been unaffected by the economic cycle.
This is in contrast to the likes of Galaxy Resources Ltd (ASX: GXY), which has seen its share price nearly halve in 2019 as lithium prices have plummeted lower throughout the year.
