It’s no secret that the ‘Oracle of Omaha’ made his fortune by capitalising on cheap shares. Warren Buffett’s lucrative yet simple investment strategy has long been to buy wonderful companies at fair prices. And successfully replicating this approach could leave investors far wealthier, in my opinion.
Of course, finding bargain-buying opportunities is far easier said than done. When the markets are behaving normally, spotting opportunities often requires building complex valuation models that even professionals struggle with.
That’s why 2023 is such an exciting time to be an investor. With many still worried about a looming recession, volatility is still high. That increases the odds of wild valuation swings. And in some instances, these could provide a lucrative entry point for long-term investors. That’s why hunting cheap shares today could be one of the wisest moves to make right now.
Focus on the long term
Cheap shares can be created in a variety of ways. A company may have just released terrific earnings that have gone unappreciated. Or perhaps a temporary hiccup in production has caused an earnings target to be missed.
Right now, there are plenty of short-term economic hurdles that businesses need to overcome. And with investors holding their stocks on a short leash, disruptions, even temporary ones, are being met with fierce drops in valuations. This is where the opportunities start to emerge.
In the case of Buffett, he’s already been going on a shopping spree, loading up on several of his existing positions to capitalise on the ongoing volatility. Even his stock picks may continue to tumble in the near term. But the long run is ultimately what matters. And businesses being punished today despite the underlying strategy remaining intact are more likely to thrive.
Value and price aren’t the same thing
In my experience, one of the best ways to find bargains is to explore the list of stocks that have performed the worst in recent months. However, investors can’t simply start snapping up sold-off stocks and expect to make a good return. In fact, this approach would likely end in disaster.
Just because the share price has fallen doesn’t make a company cheap. It’s essential to analyse the underlying business to determine an estimate of what it’s actually worth. In many cases, a rapid sell-off is likely triggered for good reasons. And the last thing any investor wants to own is a dud.
But, as previously mentioned, calculating intrinsic value is quite a hassle. Fortunately, relative valuation metrics like the price-to-earnings (P/E) and price-to-sales (P/S) ratios provide a handy shortcut.
By comparing where these metrics stand versus their historical as well as the industry average could reveal a potential buying opportunity that merits further investigation. Suppose the company is fundamentally sound with a realistic long-term strategy and talented management. In that case, investors may have just stumbled upon a cheap stock worth buying.
