One of the great things about value investing is the margin of safety that any good value investment has to offer. If you can identify a business where the stock price is not indicative of its value, then that is a much more comfortable situation to be in than one where you are betting on earnings growth that may or may not materialize. It's better to have a set of assets that you can value in the here and now than it is to project out what might happen in the future.
Of course, any investment requires at least a certain degree of projection - after all, the present value of a business is the discounted value of its future cash flows - but in general, you should want to minimize the amount of the prognostication that you need to do.
The risks and rewards of value investing
One big difference between value and growth investors is that the former just need to wait for the market to catch up to the realization that a particular company is undervalued (and to reprice it accordingly), whereas the latter is dependent on underlying growth of the business. Of course, as a value investor you always run the risk of being wrong in your judgement, but that is true of any investing style.
The bigger issue with buying cheap businesses is that in many cases, beaten down companies are actually value traps that may take a very long time to reprice higher (that is, if they do not turn out to be in permanent decline). As an investor in these businesses, you are paying the hidden opportunity cost of not being able to put your capital into more productive assets. What's more, inflation will gradually reduce the value of the cash that investors hold, effectively putting a tax on savings.
For these reasons, it is fair to question whether simply buying a highly diversified portfolio of statistically cheap stocks will yield good returns. In my view, the better strategy for would-be value investors is to start by looking at the cheapest stocks in the market, and then to further screen them to find higher-quality businesses that are less likely to end up being value traps. Gurufocus provides a wide variety of different tools and stock screeners that can help you narrow down the list of great investment opportunities.
Read more here:
- Warren Buffett: Owning Part of a Business vs. Owning All of It
- Howard Marks: The Federal Reserve Cannot Prevent Market Cycles
- Joel Greenblatt Talks About How He Got His Start as an Investor
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