Focusing on undervalued stocks to buy has historically been a successful strategy in achieving higher investment returns.
The concept is pretty straightforward – buy high-quality businesses trading at prices that don’t reflect their long-term potential, then hold them until the rest of the world wakes up and the share price increases.
This approach also has the advantage of carrying lower levels of risk. After all, underpaying for a stock provides a wider margin of safety. And it’s precisely how investors like Warren Buffett built a multi-billion-dollar fortune.
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Of course, this investing style is easier said than done. Finding undervalued stocks under normal market conditions can be tough, requiring detailed knowledge of corporate valuation. And this can be quite the rabbit hole to dive into. Fortunately, investors in 2023 have a significant advantage.
The stock market is still in the process of recovering from the 2022 correction. Consequently, the number of shares trading at a discount is more elevated than usual, making it easier to find bargains. With that in mind, here’s how I’d seek to find them.
Searching unloved industries
There are always particular industries that get left behind when most investors are busy chasing the next big thing.
Today, the artificial intelligence (AI) sector seems to be at the top of everyone’s mind. But with so many investors pursuing the opportunities within machine learning and generative AI, it’s doubtful to find any bargains here.
In fact, looking at some of the most popular stocks like Nvidia, investors currently have to cough up a massive premium that’s unsustainable, in my opinion.
Instead, those looking for bargains are more likely to stumble across a deal in industries that are currently out of fashion. And two areas I’m exploring for the best stocks to buy now are:
- Real Estate – Rising interest rates are dragging down property valuations. However, despite this, many non-office commercial real estate firms are delivering cash flow growth.
- Industrials – Supply chain disruptions and input cost inflation are causing global manufacturing slowdowns, especially in the automotive and aerospace arenas.
The problems facing real estate and industrials are tangible and have a negative impact. However, these are ultimately short-term issues. And providing that an underlying business doesn’t become compromised, a rebound may be due for many of the companies in these spaces.
Even the best stocks have risks
Cyclical industries can have prolonged periods of slow performance. And even if an investor successfully identifies top-notch enterprises, it could be years before this value is realised by the rest of the market. That’s why value investing requires tremendous patience, which not everyone has.
It’s also worth pointing out that even if a company faces a short-term problem, there’s no guarantee it won’t evolve into something more serious later.
For example, an industrial business struggling with production delays due to part shortages may start to see a rising number of orders being cancelled if a competitor fixes their supply chains faster. Or in real estate, prolonged property devaluations could force lower rental rates as new, cheaper leasing space becomes available.
In both scenarios, cash flow gets disrupted. And a once cheap-looking stock to buy can become a drag on portfolio performance.
