OK, I’ll admit - the title of this piece is somewhat misleading. Popular stocks are not the value investor’s enemy, so much as they are an obstacle to avoid. But the main point, which is that value investors need to stay away from popular stocks, stands. When it comes to any kind of investing, it is easy to lose one’s footing amid the sheer number of stocks out there.
My goal with this new series is to compile a number of rules of thumb that all value investors should use when looking for opportunities to deploy capital. When combined with screening software (like the one offered by GuruFocus), these rules can become truly powerful. Today, we will discuss why popular stocks are rarely good targets for value investors.
Why popular stocks cannot be good value
As we know, markets are not always perfectly efficient. Occasionally, stocks will be priced too highly relative to their intrinsic value. Let’s pause for a minute and think about what it means for an asset’s price to grow. It simply means there are more buyers than sellers in a market, and those buyers are driving the price higher. In other words, the asset is popular. Popular stocks, by definition, cannot be value stocks.
Now, you may think that this is an obvious, perhaps even trite, statement. But think about the messages we are bombarded with daily by the financial news media. This is just guesswork on my part, but I reckon that around 10% of the S&P 500 receives 80% of the total airtime. What does that say about those stocks? They are likely overvalued, just by virtue of being talked about so often.
A way forward
So what should the budding value investor do? Well, it stands to reason that if stocks that are popular tend to be overvalued, then the unpopular securities tend to be undervalued. Now, there is no guarantee that a widely-panned stock will be cheap. Sometimes, things are cheap for a reason - we call these value traps, and will talk about them in a future article in this series. But when buying an unpopular stock, you will at the very least know that it isn’t being propped up by trend-following investors and traders.
If it’s so easy, why doesn’t everyone do it. That’s a good question, one that needs to be answered in two parts. The first part of the answer is that value investing is not as easy as finding the most beaten-down dogs in the index and buying them up. Investing is part science, part art and part craft, but I would argue that it is much more of a craft than a science. Robotically following a formula rarely works.
The second part of the answer is more interesting, and it is that most people do not have the psychological makeup necessary to seek out unpopular assets. This is not strange - everything in our evolutionary history has incentivized crowd-following behavior. The skeptic who stayed put while everyone else ran for the trees was most likely to be eaten. But we are not in the savannah anymore, and following the crowd nowadays is arguably more dangerous than going your own way. These days, it pays to think for yourself.
Disclosure: The author owns no stocks mentioned.
Read more here:
- ”‹What Is the Real Difference Between an Investment and Speculation?
- Howard Marks: The Supreme Irony of Passive Investing
- ”‹Warren Buffett on If You Need to Go to Business School to Be a Good Investor
 Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
