Everyone knows the best time to buy stocks is when they’re trading at discount valuations. But that’s easier said than done in a lot of cases.
Falling prices usually mean that investors think buying is a bad idea. For those who can see past short-term challenges, though, the rewards for being brave can be enormous.
The risks and rewards of buying low
As an illustration, consider Meta Platforms. The stock was trading at around $120 at the end of 2022, implying a price-to-earnings (P/E) ratio of around 13.
That’s clearly unusually cheap, but the firm was facing genuine challenges. For one thing, it was losing significant amounts of money in its metaverse operations.
On top of this, Apple’s privacy changes were set to put pressure on its advertising business. But for investors who were prepared to be brave, the stock has been a great investment.
Not every stock that’s down is a buy – take Peloton for example. Between January 2021 and December 2022, the stock fell 95%, but investors who bought the dip haven’t done well at all.
Revenues have kept falling and the company continues to lose money. As a result, the share price has fallen another 20% since the start of 2023.
Buying stocks that have been falling can therefore generate spectacular results, but success isn’t guaranteed. In a few cases, though, I think the risk is worth the potential returns.
An out-of-favour growth stock
Shares in Macfarlane Group (LSE:MACF) have fallen 37% in the last six months. But I think the stock looks more like the next Meta Platforms than the next Peloton.
It’s been a challenging year for the packaging company with inflationary pressures squeezing margins and also weighing on demand. But the big issue has been more recent.
A tragic death at one of its factories caused operations to halt (obviously). An investigation is going on and uncertainty around the outcome means there’s risk for investors.
My sense, though, is that the stock market is overreacting. And I think the current share price offers a margin of safety for investors looking for stocks to consider buying.
In my view, the real highlight of Macfarlane’s business is its manufacturing division. This uses specialist technical knowledge to create bespoke packaging for high-value products.
The margins are impressive and the unit generates around £65m in revenues. I think that by itself is enough to justify the £100m enterprise value the stock currently trades at.
Being brave
In the stock market, there are always companies that are out of favour with investors. The key is figuring out which ones are opportunities and which ones aren’t.
I think there are plenty of both at the moment. Macfarlane is one I’ve been buying for my portfolio recently, but it’s not the only name on my list right now.
Over the long term, the stock market has generated good results for investors. But the best results have tended to come from buying shares when other investors don’t want to.
