I hope you know how to differentiate a company that is out and a company that is down. We have discussed these in the past and you are welcomed to check it out at our commentary section. Today, though, we are going to talk more about reasons to buy company that is down.

Why should we as investors buy companies that are down? Why don't we buy company that is out or company that is doing fine? Here are several reasons why:

Cheap. Company that is down usually sells at a discount. A company announces bad news and then the share price will drop as a result. If the company is solid and your long term picture has not improved, then the company that is down can be bought at a cheaper price than other similar companies.

Dividend. Company that is down normally has a long history of profitability. If the company is not in danger of going out of business, then it can continue paying its dividend to shareholders. Buying company that is down will give you higher dividend yield due to the drop in the share price. On the contrary, company that is out cannot afford to pay off dividend to shareholders.

Take Over Potentials. Companies would love to scoop up other companies at a low valuation. Company that is down normally have depressed share price while its core business remains intact. This is appealing to potential competitors. A lot of big investors and companies buy company on the cheap. For example, Carl Icahn the fame investor, bought Time Warner Inc. (TWX) cheap and he is trying to unlock values for the company.

High Potential Return. This is one reason investors should invest in companies that are down. The depressed share price will have a chance to recover once its short-term problem is sorted out. Company that is down normally have a low P/E ratio, many in the single digits.

It is crucial to know whether a company is down or out. There are a lot of companies selling at single digit P/E ratio, giving dividends and yet their survival is in question. These are companies that is out and not down. While, it might be difficult to identify, I can give you several examples of companies that are down: pharmaceutical companies, banking industry and companies selling hard drives. The demand for their business remains intact despite the short term downturn in the industry. However, each company within an industry is different as well. Please use the guidelines mentioned on the past article to differentiate company that is down and out.