The stock market's 50% rise since March 2020 does not mean that every listed company is overvalued. Even though the valuations of some mega-cap technology businesses are at extreme levels, I think that a number of quality businesses offer investors the chance to obtain a wide margin of safety.
One investor who had an excellent track record of identifying value investing opportunities in a variety of market conditions was Walter Schloss. His long-term focus and willingness to go against the views of his peers may have been key reasons for his outperformance of the S&P 500 over many decades.
Balance sheet strength
The current bull market may cause some investors to spend too much time considering a company's earnings forecasts. Although optimistic profit growth estimates may be met in some cases, an uncertain economic outlook means they could change significantly in the medium term.
Therefore, assessing a company's balance sheet may be a better starting point for investors seeking to identify value opportunities in today's bull market.
For instance, a firm that has a solid financial position is more likely to survive a period of challenging trading conditions. It may then be able to take part in a long-term economic recovery, which could lead to rising profitability and improving investor sentiment. It could produce higher investment returns than a stock with optimistic earnings forecasts but a weak balance sheet.
Schloss always preferred to focus on company assets, rather than earnings. As he once said, "Earnings can change dramatically. Usually assets change slowly."
A long-term view
Buying undervalued stocks is unlikely to deliver quick returns in any market conditions. It can take time for their financial performances to improve, and for investor sentiment to do likewise. Until then, value investors often face what can be a prolonged period of waiting for their holdings to deliver on their potential.
In my view, it may take undervalued stocks even longer than usual to move towards their intrinsic values given current market conditions. The economy's prospects are uncertain, and there is political risk ahead as a result of the upcoming election. These threats may lead to an extended period of challenging operating conditions for some undervalued companies, as well as weaker investor sentiment.
Therefore, when seeking to profit from value stocks, a long-term standpoint may currently be more important than ever. As Schloss once said, "When you buy a depressed company it's not going to go up right after you buy it, believe me."
Contrarian investing
Investor sentiment has improved dramatically since the stock market reached a three-year low in March. However, not all stocks have rallied in the past five months. Some firms continue to be viewed unfavorably by investors due to their uncertain near-term outlooks. This could mean that they offer wide margins of safety.
It may be tempting for value investors to adopt a similar viewpoint as their peers towards unpopular stocks at the moment. However, this may mean that you miss out on attractive buying opportunities with low valuations that have the potential to deliver stock price recoveries in the long run.
Therefore, being confident in your own ability to analyze companies and to identify value opportunities could lead to an efficient allocation of your capital. It may mean that you go against the views of other investors, but that you benefit from the opportunities for capital growth that value stocks provide in the long run.
As Schloss once said, "Don't be afraid to be a loner, but be sure that you are correct in your judgement."
Read more here:
- Peter Lynch: 3 Investment Principles to Live By
- Why Charlie Munger's Tips Can Help You Outperform
- Seth Klarman: A Cautious Investment Strategy Can Pay Off
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
