One way of thinking about investing over the long term is that it involves buying low and selling high (if one sells at all). But while the theory may sound simple in theory, in practice what may look like cheap shares sometimes go even further down, not up.
I think it is possible for me to try and double my money by hunting for stock market bargains. But not everything that looks cheap really is!
Laying long-term foundations
Sometimes shares may move up and down in the short term as investor sentiment about them changes. But in the long run, for a share to move much higher and stay there, it typically needs a suitably strong business.
I am an investor, not a speculator, so those are the sorts of opportunities I would like to find my for my portfolio.
Different reasons for valuation
But if a business has such promising foundations for it long-term business, why would its shares be trading cheaply?
It might be that the current performance of the business does not reflect what I expect it to do in future, thanks to rapid growth. That describes why I own shares in S4 Capital.
Another reason could be that the company has been marked down in price due to something I do not really think will hamper its long-term potential.
For example, shares in polymer maker Victrex look cheap to me at the moment given their long-term potential. They have been marked down for a number of reasons, such as high energy costs eating into profitability.
But ultimately I see elevated energy costs as a temporary not permanent phenomenon. I therefore expect Victrex to achieve higher profit margins in future, making me think the current price looks cheap.
Another reason can simply be that a share is out of fashion.
I think this applies to cigarette makers including British American Tobacco. I do see risks to the business such as fewer smokers meaning lower profits. But the valuation still looks cheap to me given what a cash generation machine the company continues to be.
Of course, cheap shares are often cheap for a reason. So maybe my optimism is misplaced. S4 is yet to prove its model can be profitable on a sustained basis, while Victrex could suffer from the growing costs of doing business internationally.
But I own each of these shares because I see a fundamental mismatch between the current valuation and how I assess the long-term prospects of the business.
Buy and hold
Could purchasing cheap shares like these help me double my money?
If I am a patient long-term investor, I think it could. In the case of S4 Capital and Victrex, that would simply involve getting back to a price they were at within the past five years.
As for British American Tobacco, it has a dividend yield approaching 8%. So I could double my money even if the share price is flat, as long as the dividend is maintained.
At today’s share price, I would receive more in dividends in the coming 15 years than buying the shares today would cost me. That is why I plan to keep holding them.
