Some investors may be tempted to give up on a value investing strategy in this bull market. Many cheap stocks have failed to experience improving investor sentiment over recent months. In some cases, they remain unpopular despite having solid fundamentals and wide margins of safety.
Other companies, such as large-cap technology businesses, have become increasingly popular among investors. This has pushed their prices to high levels despite many having weak fundamentals and rich valuations.
However, in my view, a value investing strategy such as that used by Benjamin Graham will beat other investment styles in the long run. Graham's ability to ignore short-term price movements and avoid overvalued stocks could be key reasons for his outperformance of the stock market over the long run.
Planning for a falling market
The stock market's 50% gain since reaching a three-year low in March 2020 may lead some investors to feel that its rise will continue uninterrupted. They may start to believe that valuations will continue to increase to even higher levels amid bullish investor sentiment.
However, no bull market has lasted forever. Ultimately, investor sentiment has always shifted from positive to negative to end every previous bull market and create a bear market. Therefore, in my opinion, a value investing strategy should be used in all market conditions to protect your portfolio from an inevitable deterioration in investor sentiment.
Stocks that have wide margins of safety and solid fundamentals in a bull market may be impacted to a lesser extent in a bear market than richly-valued companies with weak finances. This may lead to outperformance for value investing strategies versus growth strategies when the current bull market comes to its end and a bear market takes over.
As Graham once said, "Those who do not remember the past are condemned to repeat it."
Avoiding short-termism
The stock market's large recent gains in a short space of time may encourage investors to speculate on short-term price movements. They may feel that recent upward trends will continue, and they can quickly buy and sell stocks before the current bull market comes to an end.
However, in my opinion, speculating on stock prices over a short time horizon could lead to large losses. The economy faces a very uncertain future that could hurt investor sentiment in the near term. Likewise, an opaque political outlook could lead to greater risk aversion among investors that affects stock prices.
Therefore, ignoring short-term stock price movements and taking a long-term view of your portfolio via a value investing strategy may enable you to allocate capital more efficiently. As Graham once said, "Invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price."
Ignoring your peers
Being a value investor in a bull market can be tough. Investors following other strategies, such as growth investors, may have purchased overvalued stocks with weak profitability. In spite of this, they may currently be outperforming the returns of value investors due to over-optimism across the wider stock market.
In my view, comparing your performance to peers is not a productive use of your time. It is only likely to increase your frustration as valuations become more extreme as the bull market continues. A better idea is to focus on your own financial position, and whether your current capital allocation is likely to meet your long-term aims.
Graham used to ignore other market participants and focus on efficiently allocating his own capital using a value investing strategy. As he once said, "The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go."
Read more here:
- Warren Buffett on Taking Advantage of Undervalued Stocks
- Peter Lynch: Popular Stocks Don't Necessarily Make Great Investments
- Seth Klarman on Value Investing in a Bull Market
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