Some thoughts on investing in stocks that are undervalued.
Have you heard of value investing? According to Wikipedia, it involves buying securities whose shares appear underpriced by some form of fundamental analysis. Technically speaking, you’ll find such stocks in this category as trading at discounts to their book value, and may at the same time present with high dividend yields, low PE multiples and low price-to-book ratios.
The “value” designation is something that applies to a stock in a temporal manner. What I mean is that those stocks that are considered as “value” stocks at some point in time, may not be this way forever. On the flipside, those equities that may have been considered momentum or growth stocks may one day turn into value stocks when they begin presenting with characteristics that define true value.
An astute equity investor may recognize value stocks as undervalued compared to the rest of the market and look to invest in to them in some way. When the stock market winds shift, it may take down some stocks: that’s exactly what’s happened with certain investments that have been pounded heavily lately. There may be high flying shares that are now taking on a value flavor after experiencing a convincing price tumble. When such an opportunity strikes, value investors are around to sniff out the deals: their goal is to find stocks that are functioning at a much higher level than their peers, which people aren’t noticing. That’s exactly what Warren Buffett has done to become a billionaire.
Warren Buffett, Value Investing Guru
Every investor has heard of Warren Buffett, considered to be one of the world’s richest men whose made a mint from value investing. He is at the helm of Berkshire Hathaway, a holding company that has grown tremendously and on a consistent basis over the last 4 decades. While this company has done well over the long term, its shares have seen it’s own share of volatility. And while still considered by most to be the authority on value investing, Warren Buffett has come under attack lately for his buy and hold approach to investing.
Buffett has crafted his investing strategy around this premise. He’s a buy and hold investor. Now due to recent circumstances in the financial world, many now believe that buy and hold is dead, and because of such beliefs, Mr. Buffett has come under fire. In the past, when asked how long he could theoretically hold on to a stock, he’s answered, “sometimes forever.” Buffett would never cash out after short gains and would clearly avoid riding short term trends. Peaks and valleys in the market don’t interest him because his growth strategy spans decades.
Here’s some practical investment advice: Warren Buffett says that the best value investors will look for value when everybody is fearful. The best value can be found when others aren’t looking in that direction. Or as CNBC’s David Faber has said so many times, “before you know it, the worst becomes first.” What was performing the worst could later turn out to be a top performer; and if you happen to invest in a company that happens to be at its worst or lowest point, there is that chance that you’ll make some good money when it recovers.
It’s hard to argue with success. Mr. Buffett is a billionaire. When he buys stocks, the entire market moves and when he gives his opinion, the world listens. He’s still criticized for his “outdated” ideas but do you know who stops what they are doing to listen to him? His critics.
In conclusion: if you’re going to develop an investment plan, it’s wise to include value oriented equities in your portfolio — don’t ignore such assets in favor of the sexier, high flying momentum and growth stocks. By diversifying not just across asset classes (stocks, bonds, cash, real estate), but also according to various other factors such as market geography (domestic vs foreign securities) or investment philosophy (growth vs value stocks), you’ll be able to spread the risk around in your holdings.