The stock market’s performance since the start of the year has been highly irrational. However, this does not mean that value investors should adopt a similar mindset when managing their portfolios.
Instead, focusing on company fundamentals and ignoring the views of other investors could be a better idea. It could help you to apportion your capital more efficiently.
The father of value investing, Benjamin Graham, was able to maintain a rational outlook when managing his portfolio. His upbeat stance on the long-term prospects for equities despite short-term volatility could be a key reason for his outperformance of the stock market.
Focusing on company fundamentals
Investor sentiment has improved dramatically since the stock market reached a three-year low in March 2020. For instance, the S&P 500 has risen 45% since its March lows as investors have looked beyond weak current economic conditions for many businesses.
However, improving market sentiment does not mean that the return prospects for value investors have necessarily improved. Economic uncertainty could cause the operating conditions for many businesses to become even more challenging in the short run. Likewise, higher stock market valuations may mean there are now narrower margins of safety on offer than there were a few months ago.
Therefore, investors should continue to focus on company fundamentals when deciding how to apportion their capital. This strategy may allow them to avoid stocks that are overvalued based on their financial positions and outlooks. It may also enable them to find undervalued securities that are unpopular among investors, but that have the capacity to deliver capital growth over the long run. As Graham once said: “Buy not on optimism, but on arithmetic.”
Respecting the stock market cycle
The stock market cycle presents opportunities for value investors to buy stocks when they are undervalued. However, stocks are usually undervalued when investor sentiment is weak. Therefore, you must be willing to not only ignore the views of your peers, but go against them in some cases.
This can be a difficult task for any investor to achieve. It can be immensely difficult to take an opposing view to the consensus, particularly when stock prices have fallen in the preceding days and weeks.
At the moment, some sectors and companies are still unpopular among investors. They include industries such as energy, retail and leisure, which could face difficult outlooks due to an uncertain economic environment.
Identifying quality companies within those sectors could produce high returns in the long run as trading conditions and market sentiment improve.
As Graham once said, “An intelligent investor gets satisfaction from the thought that his operations are exactly opposite to those of the crowd.”
Long-term optimism
Recent market volatility and the economy’s uncertain future could cause any investor to doubt the stock market’s long-term prospects. However, it has always experienced similar risks and challenges in the past. Despite this, it has delivered an annualized return of around 10% over the past 100 years.
Therefore, value investors should maintain a positive long-term standpoint towards the prospects for stock prices. The valuations of some companies may fail to rise rapidly owing to weak financial performances even as containment measures are eased. They could even experience a further downturn later this year as political risks build, but undervalued stocks are unlikely to remain mispriced in perpetuity.
Graham previously highlighted that it was necessary for value investors to adopt a positive outlook on the stock market’s long-term prospects: “Without a saving faith in the future, no one would ever invest at all. To be an investor, you must be a believer in a better tomorrow.”
Read more here:
- Warren Buffett on Adapting to a Chainging Investing Landscape
- Seth Klarman on Managing Your Time Efficiently
- Charlie Munger on Managing Your Portfolio in a Turbulent Market
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