A bargain is a bargain, right? We seek those opportunities that may be undervalued by others right now. But there are other types of bargains lurking, too: those opportunities that get the label of overvalued right now… but may actually have years of growth ahead of them!
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One of the basic distinctions made in the stock market is between growth and value. Growth stocks offer the potential or history of above-average growth in revenues and earnings. Investors are buying a brighter future.
Value stocks present a low cost in terms of price for a current dollar of earnings, or price/earnings (P/E) ratio. In the late 1990’s growth stock boom, value stocks were derided as “old economy” stocks. The exciting “new economy stocks,” computer chip and internet and fiber optic companies, were all firmly in the growth camp.
Investing in growth worked well until it didn’t. Value stocks went nowhere until the Tech Wreck, when growth stocks peaked and then fell a long way. The stock market often experiences periods where one of these factors outperforms, and the other one lags.
A recent article at MarketWatch.com1 detailed the work of a Wall Street analyst who claims that value stocks are at their biggest discount relative to growth in many years. The charts show that valuation differences generated by a decade of strong growth stock returns put value stocks at perhaps the biggest discount in history relative to growth.
In plain language, the bargain stocks have generally become bigger bargains.
When there are sound reasons for expecting better stock prices at some point in the future, we may own companies that are underwater, or down from what we paid for them, for an extended period.
We strive to own the best bargains. It is hard to watch as bargains become even better bargains while more expensive stocks do better. But we know how this works. We believe that sooner or later the bargains will produce gains.
If the differences in valuations are at extreme levels, perhaps the trend change is coming sooner rather than later.
Clients, if you would like to talk about this or anything else, please email us or call.
We have seen many clients make the journey to become more effective investors with more productive attitudes, beliefs, and habits. We are proud of the client who made the longest journey of all. Because it has so much potential for so many others, we are telling the story of W, our client, in this series of three posts.
W reached a place in his career where he had money to invest in the late 1990’s. He consulted us about investing—but did not become a client then.
Our principles led us to conclude that the red-hot technology sector, which everybody seemed to be buying, should not be purchased. The bargains we preferred were incredibly boring to W. An annual dividend of a few percent was not appealing compared to the prospect of continued 30-40% gains from the shooting stars.
(Long-time followers will recognize our three principles in this episode: avoid stampedes in the market, find the biggest bargains, “own the orchard for the fruit crop.”)
After the wheels came off the technology boom and W lost half his money, he brought what was left of his portfolio to us.
Many victims of the massive decline that began in 2000 learned the wrong lesson. Although ‘old economy’ companies held their own or gained while tech stocks plummeted, some learned that “the stock market is dangerous.” The correct lesson, of course, is that popular but over-priced assets are dangerous.
W, to his credit, had learned the right lesson. He remembered the advice he did not take, saw how that would have worked, and became a client. Meanwhile, the people who learned the wrong lesson sold out and usually went on to repeat their mistake elsewhere.
This was the first leg of the journey of W, where it really began. But he was not an effective investor, yet. Two more lessons were needed, further along the path.
We’ll be writing about those next two lessons in the days ahead. If you just can’t wait to learn the rest of the story, or want to talk about your situation, please call or write.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
This is a hypothetical situation based on real life examples. Names and circumstances have been changed. To determine which investments or strategies may be appropriate for you, consult your financial advisor prior to investing.
Stock investing involves risk including loss of principal.
The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.
“It’s easy to poke holes in every single investment philosophy or strategy. The trick is to find the one with flaws that you’re comfortable with.” –Ben Carlson, Ritholz Wealth Management
This concise statement makes it clear: every investor faces tradeoffs.
Current Income or Long Term Growth? Some strategies focus on growth in capital over time, others focus on current cash flow. Many investors need some of each. A pure growth portfolio probably won’t pay your bills, and a pure income portfolio may not have the growth to stay ahead of inflation.
Stability of market value or long term growth? This is where we live! We have written about the high price of stability. And we have constantly communicated in every way we know how about the link between long term returns and short term volatility. Everybody we know would prefer having both stable values day to day and wonderful long term returns.
You cannot have all of both—the best we can do is some of each. But it helps to resolve this tradeoff if you make sure your income and emergency funds are sufficient for your needs. If you own the orchard for the fruit crop, you don’t need to care what the neighbor would pay you for the orchard today.
Reliability of Income or Stability of market value? This dilemma is not even recognized by most people, and rarely discussed by investment professionals in our experience. Nevertheless it is a vital point. At one extreme, the kinds of investments that assure stable values have delivered wildly varying income over the years. In the early 1980s one could gain interest of 1% a month on money in the bank. More recently, it has been difficult to get 1% per year. So the person that retired on bank deposit interest of 12% saw a lot of volatility—and deterioration—in their income over time. Meanwhile, anything you can own that produces reliable income over extended periods will definitely fluctuate in market value, sometimes sharply.
Putting it all together: As you can see, every investment strategy has flaws. The trick, as Carlson says, is to find the one with flaws that you’re comfortable with. So we need to understand what is required in the way of stability, current income, reliability of income over time, and long term growth. We can build a portfolio that strives to balance those attributes with tradeoffs that are both acceptable and likely to be successful.
Please call if we may be of service in this regard, or to update our understanding of your situation.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.