The stock market’s rise since March lows make it more difficult for value investors to identify buying opportunities. Some stocks now offer narrower margins of safety than they did earlier in the year, while others may be overvalued after the S&P 500’s 40% rise since March 23. In addition, investor sentiment could change rapidly in a short space of time due to the economy’s uncertain short-term outlook.
Seth Klarman (Trades, Portfolio) has experienced a number of similar situations during his investment career. The Baupost Group chairman’s focus on fundamentals could thus be beneficial for investors to study in order to seek opportunities in a rising market.
Focusing on company fundamentals
Some industries are currently out-of-favor with many investors, despite the stock market’s recent overall rise. These include sectors such as travel and retail, which face highly uncertain futures due to lockdowns and weak balance sheets.
However, there may be buying opportunities within unpopular industries. For instance, dominant businesses with strong balance sheets could increase their market share as their competitors fold under challenging conditions. Buying them while investor sentiment towards the sector in which they operate is negative may mean there are wide margins of safety on offer. As Klarman once said, “The herd mentality of investors can cause all companies in an out-of-favour industry, however disparate, to be tarred with the same brush.”
Apportioning capital efficiently
The stock market’s recent rebound from its March lows could mean that some companies no longer offer wide margins of safety. They may even be overvalued on a relative basis at a time when their prospects are difficult to predict.
Therefore, selling them could be a logical strategy if there are superior opportunities on offer elsewhere within the stock market. This approach is not the same as timing the market. Rather, it seeks to apportion your capital to its most efficient use in terms of its capacity to produce high returns given the risks present. Even if you think a stock will continue to rise, there may be better opportunities out there.
As Klarman once said, “Decisions to sell, like decisions to buy, must be based upon underlying business value. Exactly when to sell or buy depends on the alternative opportunities that are available.”
Regular investing
Instead of fully investing all of your available capital in a short period of time, it could be a better idea to invest smaller amounts regularly at the moment. A recession would cause company earnings to disappoint, which may lead to weaker investor sentiment.
Investing regularly in smaller amounts means that you can benefit from a stock market decline in the short run to buy quality companies at lower prices. A regular investment strategy may also reduce the mental anguish that can afflict many investors who experience losses on their investments soon after buying stocks.
Klarman once discussed his preference for a strategy that seeks to invest smaller amounts more often:
“Investors should usually refrain from purchasing a ‘full position’ in a given security all at once. Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve. Buying a ‘partial position’ leaves reserves that permit investors to average down, lowering their average cost per share, if prices decline.”
Read more here:
- Charlie Munger on Maximizing Your Returns in a Volatile Market
- Howard Marks on Investing After a Market Rally
- Warren Buffett on Buying Stocks When Other Investors Are Selling Them
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