Value Investing Is All About Bargain Hunting
Buy low, sell high. Repeat
I love deals. And if you’re a treasure hunter like me, your antenna is always up. Consider winter coats. As we head into summer, retailers like TJ Maxx and Ross Stores are unloading last year’s stock of winter clothing at discount prices. Now would be a perfect time for bargain shopping, especially if you’re seeking overall quality, rather than keeping pace with the latest trends. If you went shopping for winter coats this weekend, you’d likely find some quality options for 50% or 60% off compared to what you’d pay in November when everyone is on the winter coat train and inventories are short.
As an investor, I want a deal on my stocks as much as I want a deal on my winter coat. The essence of both propositions is to buy for less than what the assets are worth.
Treasure hunting for stocks is tough work, though. It takes diligence, patience and a willingness to sort through heaps of possibilities before settling on the right assets. And you always need to be wary of fool’s gold. Just because the market sentiment around an asset switches from hot to cold doesn’t mean we should follow suit. It often means the opposite.
When we search for investing bargains, we’re looking for strong companies with solid fundamentals and a margin of safety. Fundamentals are attributes like price, profitability, revenue, assets, liabilities, and growth potential. A margin of safety can be assessed by looking at a company’s market share and competitive advantage, and can be crucial to hedge against unknowns. Of course, there is always an element of risk - no amount of research will eliminate that. What we’re talking about here is understanding a company’s relative price and its position within the marketplace.
The impact of volatility
Let’s look at how the volatility introduced by COVID-19 impacted Ross Stores. In March of 2020, most brick-and-mortar stores were shuttered and there was no immediate relief on the horizon. Ross Stores hit a low of $60 per share on March 23, 2020. In March of 2019, Ross was trading at a price of $100/share, and was growing by an average of 10% per year. Ross Stores, like many other retail stocks, was in the bargain bin in Q2 2020. But in Ross’ case, because the depressed stock price paired with strong fundamentals, it was reasonable to attribute a margin of safety when considering buying the dip. Ross, like many other retailers, weathered the storm and rebounded from their lows of 2020, and as of this writing is trading at $124 a share.
The impact of bargain shopping
The S&P 500 has given investors an average annual return of 10% since its inception in 1926. We’ll use that average rate of return to illustrate how bargain shopping can bolster future returns. Let’s say that you've been researching stock X and feel that it’s worth between $90 to $110 a share. Its current market price is $110, and it’s current true or intrinsic value is $100. Since this falls within your target range, you buy it at this price. With a true value price of $100 and an average return of 10%, in five years, one share of stock X would be worth $161, with an average annual return of 7.92%, as illustrated below.
But what if you didn’t buy it at $110 per share, and waited instead? Thanks to short-term volatility (aka market noise) the market price dropped to $90 per share and you bought it then. In five years, your return would be 12.34%. That’s value investing in action.
Take the level of risk you’re comfortable with
Trying to take advantage of deals in the market can be unsettling. Oftentimes, it requires you to be a contrarian. You don’t get deals when you do what everyone else is doing. When you buy into the latest trends, fads or fashionable investments, you tend to pay higher prices. But if you leverage available analytics and conduct careful research, you can often find value in assets that have been overlooked.
The important takeaway is the underlying principle spelled out by Warren Buffet, the ultimate value investor. He suggested you should be fearful when others are greedy, and greedy when others are fearful. To put it another way, you can often find quality options at value prices when you take the time to look through the bargain bin.
If you’d like to learn more about how you can integrate value investing into your portfolio, schedule a meeting with one of our fiduciary advisers, at no cost or obligation.
Adam K. Wright, CFA, CFP®
Adam guides the vision and implementation of the firm's fiduciary service approach and directs client engagement, service integration and investment management practices.
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