A wide range of well-known investors have generated high returns by following a value investing strategy over recent decades. For example, Berkshire Hathaway’s (BRK.A, Financial) (BRK.B, Financial) Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio), as well as Baupost founder Seth Klarman (Trades, Portfolio), have generated exceptional returns over long periods of time by buying undervalued stocks and holding them for the long run.
As a result, many investors may seek to emulate their success. In my opinion, now is the perfect time to begin that journey. After all, the stock market has fallen by around 18% since reaching a record high earlier this year. A wide range of companies now trade at large discounts to their intrinsic values. This means there are opportunities to buy them at what could prove to be bargain prices.
A long-term focus
Clearly, the stock market’s performance could further deteriorate in the short run. Risks to the economy’s future performance, such as rising interest rates and high inflation, could prompt a decline in stock prices across a range of sectors.
However, the threat of short-term paper losses has not previously prevented well-known value investors from buying undervalued shares. After all, they have a long-term time horizon that means the short-term performance of their holdings is somewhat irrelevant. Of far greater importance to them is the acquisition of stocks when they trade at temporarily low prices.
Indeed, this point has previously been discussed by Seth Klarman (Trades, Portfolio), who said, “Value investing is the discipline of buying shares at a significant discount from their current underlying values and holding them until more of their value is realized. The element of a bargain is the key to the process.”
A broader range of concerns
Of course, there is much more to value investing than simply buying cheap stocks. Value investors consider both the price of a stock and its quality when determining whether it is worthy of purchase.
Clearly, an assessment of a company’s quality is highly subjective. Different value investors will have a variety of opinions on which companies are attractive. However, they are likely to be based on common factors such as balance sheet strength, how a company’s competitive position compares to its peers and the appeal of its long-term growth strategy.
In my view, investors can most effectively gauge the quality of a company by focusing on its fundamentals and by developing detailed knowledge about a specific industry. For example, figures such as debt-to-equity ratios, interest coverage and return on equity can provide guidance on the financial strength of a business and its market position. Meanwhile, value investors who understand a specific industry can more easily determine which incumbents are the highest quality investment opportunities.
A value investment
Value investors continually seek to purchase high-quality companies when they trade at bargain prices. With there having been just 27 bear markets since the Wall Street crash in 1929, today’s bear market presents a rare opportunity for investors who are interested in a value strategy to get started. After all, the stock market’s track record of recovery shows that today’s low prices are very likely to only be available temporarily.
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