The stock market's recent rise means that unearthing attractive buying opportunities may be more difficult than it was previously. Higher stock prices can mean higher valuations, as well as narrower margins of safety.
Therefore, following the views of value investors such as Joel Greenblatt (Trades, Portfolio) could be a good idea, in my view. His focus on unpopular sectors and an ability to ignore emotions could be key reasons for his long-term outperformance of the stock market.
Search within unpopular sectors
The increasing popularity of large-cap technology stocks has been a main driver of the current bull market. Stocks such as Apple (AAPL, Financial) and Facebook (FB, Financial) now trade on price-earnings ratios of 38 and 33, respectively, while some of their industry peers also have extremely rich valuations. This may mean that they offer narrow margins of safety for new investors.
However, not all sectors have experienced such strong gains since the stock market's March lows. Therefore, it could be a good idea to focus your energies on industries that are currently less popular among investors. They may offer lower valuations and more attractive risk/reward opportunities for new investors.
For instance, industries such as energy, consumer products and financial services may contain quality companies that trade on low valuations due to an uncertain near-term economic outlook. Buying them, rather than highly-rated stocks, could provide greater capital growth potential.
As Greenblatt once said, "If you spend your energies looking for and analysing situations not closely followed by other informed investors, your chance of finding bargains greatly increases."
Focus on the facts
The stock market's 50% rise since March may cause some investors to become overly-optimistic about its future prospects. For instance, they may feel that investor sentiment will continue to improve and extreme valuations can be justified via exceptional earnings growth forecasts.
However, it is crucial to base your decisions on facts and figures instead of emotions. The economy's uncertain outlook and the upcoming election may mean that investor sentiment changes in future. This could leave stocks with rich valuations and poor fundamentals exposed to significant stock price declines.
Therefore, analyzing a company's balance sheet, economic moat and long-term growth strategy may be just as important now as it is during a bear market. It may improve your capacity to find the best stocks trading at the lowest prices, which could lead to an efficient allocation of your capital.
As Greenblatt once said, "Decisions to buy and sell stocks should be based solely on the investment merits."
Ignore recent trends
Even though the stock market's recent trends have been positive, no bull market has ever lasted forever. For instance, the longest bull market in history lasted for 13 years between 1987 and 2000. This means that relying on the continuation of recent upward trends to unearth buying opportunities may be a deeply flawed strategy that leads to disappointing investment performance.
Likewise, avoiding stocks that have failed to keep up with the wider market's recent rise may mean that you overlook attractive value investing opportunities. Stocks with disappointing recent performances may offer wide margins of safety, and could deliver successful recoveries in the long run. They may have a competitive advantage that other investors have overlooked, which could lead to an improving financial performance.
At its core, value investing centers on buying quality businesses when they trade at low prices. Therefore, in my opinion, past stock price performance is irrelevant and should be ignored when seeking to find buying opportunities in any market conditions.
As Greenblatt once said, "Using past price movements as the basis for determining the riskiness of a particular stock can often lead to faulty conclusions."
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Warren Buffett on Preparing for the End of This Bull Market
- Walter Schloss on Taking Advantage of Value Investing Opportunities
- Peter Lynch: 3 Investment Principles to Live By
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
