Great investors often have one strong commonality: They look at stocks as a piece of a living, breathing business. But beyond that, they have many different ways to approach the game. Even within our office here at The Motley Fool Singapore, we have investors who invest in vastly different ways (though it must be stressed that we all still look at stocks as a piece of a business) and yet achieve similarly good results. Despite the myriad ways in which different investors use to describe their strategies, when it’s all said and done, it boils down to two reeds: Buying…
Great investors often have one strong commonality: They look at stocks as a piece of a living, breathing business. But beyond that, they have many different ways to approach the game.
Even within our office here at The Motley Fool Singapore, we have investors who invest in vastly different ways (though it must be stressed that we all still look at stocks as a piece of a business) and yet achieve similarly good results.
Despite the myriad ways in which different investors use to describe their strategies, when it’s all said and done, it boils down to two reeds:
- Buying a great business at a fair price, or
- Buying a fair (or lousy) business at a great price
This article will be digging into what it means to buy mediocrity (or lousiness) at a great price and it is part of a two-part series which takes a closer look at the two aforementioned ways of approaching the art of fundamentals-based investing.
The concept of investing in a deeply undervalued company was made popular by Benjamin Graham, with his investing tome Security Analysis.
Generally speaking, an investor who follows Graham’s philosophy would tend to focus more on the easily quantifiable numbers of a company (such as the value of its assets and liabilities) to ascribe an intrinsic value to the business. The investor would then only invest in the stock of a company if it was selling at a price that’s significantly lower than the estimated intrinsic value.
The quality of the business itself is a secondary matter – what matters is that it’s cheap. And because companies with quality businesses tend to not be available for bargain-bin prices, what such investors are often left with are companies with mediocre or downright lousy businesses.
For an idea of what a cheap stock may look like, we can look at a firm like the commodities trader Noble Group Limited (SGX: N21).
At its current price of S$0.565, it’s only trading at 54% of its total assets net of all liabilities. In other words, if the reported value of Noble’s assets accurately reflect their true economic values, then investors may be getting a nice discount on the company’s assets.
It’s the same with Ezion (SGX: 5ME). The owner of vessels providing offshore support services has a price-to-book (PB) ratio of only 0.70 at the moment with its share price of S$0.80.
As an even more extreme example, we can look at a firm that’s undergoing liquidation. If its shares are still selling at a price that’s lower than its liquidation value, a bargain hunter may well snap up its shares and make a profit through the spread between the purchase price and the liquidation value.
It’s important to note that buying mediocre and/or lousy companies at a great price is often done with a timeframe in mind. That’s because unlike great companies that can compound value for their investors, a mediocre business can’t, or can only do so at a very low rate.
With a time frame in mind, if the investment does not pan out, the investor can then move on to the next idea.
On the negative side, investing with this strategy might cause the investor to fall into “value traps.” Value traps are companies that look cheap, but are in fact still expensive because the intrinsic value of their businesses are in fact much lower than what appears on the surface. This can then result in losses for the investor.
Another negative aspect to buying mediocrity is that when a company’s price finally moves up to your target, you’d have to sell and then recycle your capital into a new opportunity. The constant need to search for new ideas can become a really taxing event.
The good news is that if buying mediocre businesses at cheap prices is done properly, it can result in consistent returns for investors and also lower the chance of suffering large losses (the act of buying cheap in itself helps to provide protection on the downside).
That’s all I have for buying a fair or lousy business at a great price. For more on the other approach, you can hit the link here. There really is no right or wrong choice between the two as there are great investors who have succeeded with either way. It’s more important to stick with what suits your temperament the most.
There's a lot more to talk about when it comes to investing strategies and if you'd like to do so in person, you can come meet David Kuo and the rest of the Fool Singapore team on August 15!
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any companies mentioned.