Despite its recent decline, the S&P 500 has still gained over 90% since the March 2020 crash. As a result, it has gradually become more difficult to unearth shares that trade significantly below their intrinsic value. Indeed, a relatively large number of stocks now seem to lack any margin of safety due to buoyant investor sentiment over recent months and an upbeat long-term economic outlook.
Of course, this situation is not unusual. Company valuations have often risen to levels that make them unappealing to buyers during previous bull markets. By their very nature, periods of significant stock market gains lead to improving investor sentiment that, in turn, further catalyses stock prices in what may be viewed as a "vicious cycle" for prospective buyers.
This situation has previously been discussed by Oaktree Capital founder Howard Marks (Trades, Portfolio). As he once said:
“I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality. That means the best opportunities are usually found among the things most others won’t do. After all, if everyone feels good about something and is glad to join in, it won’t be bargain-priced.”
Unearthing bargain shares
Of course, the stock market’s gains over the past couple of years do not necessarily mean that bargain stocks have become extinct.
Certainly, some sectors have become insanely popular among investors. For example, online-focused businesses that have benefitted from the accelerated shift towards the digital world during the pandemic now trade on excessively high valuations in some cases.
However, other industries continue to be relatively unpopular among investors. For instance, the global banking sector remains unfavored compared to other industries due in part to continued low interest rates that limit profit growth.
Similarly, the ongoing transition to renewable forms of energy could mean businesses that rely on fossil fuels, such as oil and gas companies, have relatively low valuations. Investors may be cautious about their financial prospects in a world economy that is increasingly concerned about climate change.
As such, undervalued, and even bargain, stocks may still be on offer. As Marks suggests, though, investors may need to be prepared to invest in sectors and companies that their peers are largely avoiding.
A long-term plan
Despite the potential to find bargain stocks in the current bull market, investors must also be realistic. As mentioned, the stock market has surged significantly higher in recent months and has reached new record highs along the way. As a result, unearthing mispriced stocks that trade significantly below their intrinsic value is likely to be relatively challenging.
Long-term investors may, therefore, wish to wait for superior opportunities to present themselves. Estimating when the stock market will enter a bear phase is impossible. However, preparing for it through selling overvalued holdings and holding a proportion of capital as cash may be a prudent move.
It could allow value investors to purchase bargain shares during the next stock market crash when most other investors are likely to be selling high-quality stocks for far less than they are worth.
Also check out:
