Just because a share is cheap, doesnt mean its an investment bargain. If, like me, youve ever bought a stock because it surely cant fall any further – in my case, the now-bankrupt services group Jarvis – youll have learned that the hard way. The trick to finding value stocks is to pick up good companies at great prices.

But where do you start? There is no single magic number that is a guaranteed buy signal. However, here are four relatively easy ways to screen for a bargain.

1. Income – dividend yields

There are only two reasons to buy a share: for income or for growth. Which is best? Investors often consider capital growth alone when they look back at the shares they wished theyd bought. But in fact, income is far more important. Over the past ten years the FTSE 100 has been all but flat. But throughout the last decade, barring one or two blips, such as the recent BP debacle, big blue chips have carried on pumping out dividends. Indeed, as GMOs James Montier notes, in Europe, 80% to 100% of the total returns achieved since 1970 have come from dividends.

For investors, therefore, yields (the annual dividend as a percentage of the current share price) matter. And the good news is that, for now at least, the FTSE 100 is offering a yield of around 3.5%, which pips the return on long-term gilts. And plenty of solid blue chips offer more. Before diving in always check dividend cover – the number of times the annual dividend could be paid out of profits

after tax. Again, the news here is good. On average FTSE 100 companies are covering their dividends at least twice.

2. Growth – price/earnings ratio

The next check is a firms price-to-earnings ratio (p/e). As a rough guide this tells you how long the market expects to wait to get its money back, ignoring inflation. So a p/e of, say, 15 suggests that if earnings dont grow, you will wait around 15 years to recoup your initial investment. The lower the p/e and the stronger the company, the better the chance of bagging a bargain.

One way of testing whether a low p/e ratio represents value or not is the price-to-earnings-growth (PEG) ratio. This compares the p/e to a firms earnings growth rate. If this years earnings are £100m and next years are expected to be £110m, the expected earnings growth rate is 10%. If the firms p/e is eight times then the PEG ratio is 0.8 (8/10). A PEG below one suggests that the firm is cheap. A high PEG, on the other hand – say, two or more – implies that a firms earnings growth is being offered too expensively.

3. Assets – price-to-book ratio

If you were buying a business youd want a list of its assets (the stuff it owns) and its liabilities (the amounts it owes) so that you could work out what its net assets are worth. The principle is similar to trying to work out your net equity in a property – if a house is valued at £350,000 but carries a £50,000 mortgage, its net value to the homeowner is £300,000.

For investors, price-to-book ratios (p/b) compare a companys market value with the book value of its balance-sheet net assets. So if a firms market capitalisation is £100m and its balance sheet net assets are £150m, the p/b is 0.67. That means the shares are available at a discount to net asset value (NAV) – a good sign in the hunt for a bargain. Its not a perfect test, balance sheets often exclude intangible assets, such as brands and people. So in sectors such as software development, the balance sheet may be largely meaningless. But its still a useful check, particularly for asset-rich sectors, such as investment trusts and property companies.

A well-known modification is Tobins Q. This compares a firms (or sectors, or even a whole economys) market capitalisation to the cost of replacing its assets at todays prices. The latter involves a fair bit of guesswork, but in principle if the ratio is less than one, firms are priced cheaply and may be vulnerable to takeover. Once Tobins Q climbs much above one, existing firms start to look overpriced. In a sector this sets the scene for new rivals to enter and undercut any incumbents (assuming low barriers to entry).

4. Cash – price to free cash flow

Dividends can be cancelled, earnings manipulated and assets mis-stated by directors. But cash flow is harder to mess around with. So a good test for value is the firms market capitalisation against one years free cash flow. Thats the cash from a firms operations, subtracting non-discretionary spending on interest payments, tax, and the amount needed to replace existing fixed assets. The lower the ratio, the better.

What to buy

Several blue chips look good on these criteria – here are two of the best. The first is Melrose (MRO), which seeks out underperforming industrial firms and looks to turn them around. The dividend yield for 2010 is 3.7%, covered 2.3 times. The p/e is 11.2 and the PEG 0.4. Another decent bet is supermarket Tesco (TSCO). While growth is slowing, the brand is solid and offers a forward yield of 3.5%, covered 2.3 times, with a p/e slightly below the FTSE average at 12.8 and a PEG of 1.2.