The stock market has made strong gains since its March lows, but there could still be buying opportunities for value investors.
A number of sectors are unpopular among investors at the moment due to their uncertain outlooks. This could mean that they contain quality businesses trading at attractive prices.
Oaktree Capital co-founder Howard Marks (Trades, Portfolio) has previously purchased unloved stocks when their outlooks have been highly uncertain. His attitude toward risk and a willingness to go against his investing peers, as detailed in his 2011 book, "The Most Important Thing," may explain his market-beating returns over the long term.
A wide range of unloved stocks
There are always stocks that are unpopular among investors, but at the moment there are numerous businesses trading at low valuations due to investor pessimism regarding their financial prospects.
For example, shares in many travel and leisure companies, retailers and other consumer-focused businesses are in low demand among investors due to their uncertain financial outlooks. For some of these companies, a low stock price may be deserved. But for others, a cheap stock price could represent a buying opportunity for value investors.
The inherent appeal of buying unloved stocks to access favorable risk-reward opportunities was highlighted by Marks in his book. He wrote:
“The safest and most potentially profitable thing is to buy something when no one likes it.”
Temporary versus permanent losses
Investing in any stock could lead to a loss over a short period of time. However, the present uncertain economic outlook that is causing heightened volatility across the stock market may increase the chances of experiencing losses in the near term.
This shouldn’t cause fear or panic among value investors. Share prices are impossible to accurately predict in the short run, and can move sharply in either direction. If they are quality businesses with wide economic moats, they are likely to recover over the long run even if investor sentiment toward them is weak at the time.
This view is discussed by Marks, who is seemingly unconcerned about the prospect of experiencing temporary setbacks from holdings within his portfolio:
“The possibility of permanent loss is the risk I worry about.”
Financial strength
Buying unloved stocks with uncertain futures may mean that your holdings are likely to experience difficult operating conditions in the short run.
Therefore, it is paramount that your holdings have the financial strength to cope with difficult trading conditions that may persist for an extended period of time. For example, manageable amounts of leverage and large cash positions could be prerequisites for investors who are considering the purchase of a business.
Marks identified the importance of a company’s financial strength, alongside an investor being able to adopt a sound mindset, in his book:
“Patient opportunism, buttressed by a contrarian attitude and strong balance sheet, can yield amazing profits during meltdowns.”
Stock market cyclicality
The economy’s uncertain outlook may have caused investor sentiment toward some stocks to be weaker than it has been for many years. But it is part of the stock market’s cyclicality that has been in existence since companies began first being bought and sold by investors.
Therefore, investors should not hold the view that pessimism among their peers will last in perpetuity. It is highly likely to be replaced by optimism over the long run.
Marks noted in his book that stock market cyclicality is a constant:
“Cycles will never stop occurring. If there were such a thing as a completely efficient market, and if people really made decisions in a calculating and unemotional manner, perhaps cycles (or at least their extremes) would be banished. But that’ll never be the case”.
Read more here:
- Warren Buffett’s Tips on Using Economic Uncertainty to Your Advantage
- Peter Lynch's Tips on Dealing With Stock Market Uncertainty
- Benjamin Graham on Buying Stocks in a Market Downturn
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