The Iconoclast Investor

Many years ago, I was taught to believe that value investing, using fundamental analysis, is the best long-term approach when making investment decisions. I was taught to buy stocks at bargain prices and wait patiently until they become overpriced.

In the years since, I learned some growth and momentum techniques as well. I never argue whether one approach is better than another. But I do believe in using more than one methodology when choosing stocks to diversify my portfolio; broad diversification reduces risk significantly. Thus my portfolio contains a mixture of growth stocks and value stocks.

In previous Cabot Wealth Advisories, some of the other Cabot editors have described how to find the best growth stock opportunities. Today I will describe my methodology for discovering sound value stock opportunities.

I have two favorite approaches to find stocks that are selling at bargain prices.

The first is to find stocks that are cheap, and I use Benjamin Graham’s criteria to guide me. Benjamin Graham is known as the father of value investing and Warren Buffett is his most famous protégé. Why try to re-invent the wheel when a proven, excellent system is there for the taking?

In his book, “The Intelligent Investor,” Mr. Graham details seven criteria to identify a bargain stock. Included in his criteria are: low price-to-book value ratio, low price-to-earnings ratio, strong balance sheet, some earnings growth and no earnings deficits during the last five years. In addition, the company must be currently paying a dividend and the future outlook for the company must be positive.

I know what you are thinking–this is old-fashioned stuff and won’t work in today’s fast-paced stock market. But that’s not true; Warren Buffett has become the richest man in the world using the old-fashioned knowledge he gained from Benjamin Graham.

If a stock meets all the criteria, and is trading well below its fair value, I use my checklist as described above and wait … and wait … and if necessary I wait some more for the stock to reach my Minimum Sell Price.

Warren Buffett has said, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

What about us ordinary investors who can’t wait 10 years? I have an easy solution–I buy when a stock is undervalued and sell when it becomes overvalued. Historically, it takes about two years for this to happen, on average.

The basic principle is simple: The stock market and the individual stocks that make up the stock market have always bounced back and forth from overvalued to undervalued to overvalued, over and over again. As a value investor, I am simply taking advantage of the fluctuations of the stock market.