Last century, economist and investor Benjamin Graham laid out the principles of value investing in his books. And one of them is The Intelligent Investor, a copy of which sits on my bookshelf.
Warren Buffett thinks it’s a great read. He studied under and then worked with Graham. He also began his investing career following Graham’s market principles, which included buying shares when they assigned a low valuation to the underlying business.
Why I’m looking for very cheap shares to buy
The idea back then was that a low valuation would offer some protection against downside risks for shareholders because the stocks were already on the floor. However, it’s worth noting that low valuations often occur because of a reason.
And I think it’s also good to remember that back in the 1970s, Graham himself declared that deep-discount value investing tended not to work anymore. Indeed, Buffett abandoned the strategy in favour of buying the stocks of “wonderful” businesses when they sold at fair valuations. Previously, he’d been buying businesses that were often damaged at cheap valuations.
Of course, Buffett now combines the value component of Graham’s teachings with more emphasis on quality. He likes to cite Philip A Fisher as an investor who inspired him to search for quality, growing businesses that he could hold for a long time. And I’ve got Fisher’s book Common Stocks and Uncommon Profits on my bookshelf next to Graham’s.
Nevertheless, I reckon looking for low valuations remains a good jumping-off point for further research. And not all cheap stocks have damaged underlying businesses. For example, cyclical businesses can end up with low-looking valuations when their profits have been high for a while.
Peter Lynch taught me that investors are always looking for the next cyclical move in profits. His book Beating the Street explains things well. So, when profits have been high, the next cyclical move is likely to be lower profits. And that’s why cyclical firms tend to have lower valuations when they appear to be trading well in their businesses — investors dare not bid up the stock price for fear of an earnings collapse in the months ahead. But investing in cyclical companies is fraught with difficulties. And timing is the biggest challenge.
Low earnings multiples
However, I’m running the calculator over cyclical shares with forward-looking earnings multiples below 10. There are some good examples among mining companies, such as Central Asia Metals, Atalaya Mining, Evraz, Pan African Resources, Polymetal International and Sylvania Platinum. And some of the housebuilding companies look cheap, such as Barratt Developments, Bellway and Redrow.
In other sectors, I’m considering cyclicals such as automotive retailer Marshall Motor Holdings and maritime & logistics services provider Ocean Wilsons Holdings. But cyclicals aren’t the only cheap shares around. Other out-of-favour stocks on my list for investigation include private label household and personal care products maker McBride, troubled clothing retailer N Brown and smoking products provider British American Tobacco.
I haven’t finished my research into these opportunities. But they’re high on my list of potential candidates and could prove to be some of the best dirt-cheap shares to buy in August and beyond. Although a positive investment outcome isn’t certain just because the valuation looks low.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco and Redrow. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.