From little acorns grow mighty oaks. I think that can also be true when it comes to personal finances. Buying cheap shares in great companies can lead to a stream of dividends as well as capital gains.
The challenge, though, is finding them.
Cheap shares can be cheap for a reason. It is not common for great businesses to trade at knockdown prices.
Right now, though, I reckon that is exactly what is on offer in the London stock market. Indeed, lately I have been stuffing my portfolio with value shares like ITV and Vodafone in the hope of building future wealth.
Here is why I think this could be a great opportunity.
Importance of valuation
A great business should be able to generate substantial profits far into the future.
But there is a difference between a great business and a brilliant investment. After all, other investors may spot that a business has outstanding potential and drive up its share price.
Buying into a great business at the wrong price could turn out to be a bad move for me as an investor.
That is why I look for cheap shares.
If I can buy into excellent businesses for less than I think they are worth in the long term, then hopefully I could benefit over the course of time.
Hunting for value
But with companies publishing their financial reports free for everybody to read, what advantage do I have?
After all, millions of other investors can read the same information and draw their own conclusion about whether a company is undervalued.
Like legendary investor Warren Buffett, I stick to my own circle of competence when investing. That should make it easier for me to assess a company’s prospects.
But even so, I could still be competing in a crowded market. I think assessing Tesco is within my circle of competence as an investor, for example. But so too do potentially thousands if not millions of other investors (including, at one point in the past, Warren Buffett himself who bought into the chain and later sold his stake at a loss).
But, as that example shows, different people make different judgments at different points.
Some investors may look at a share and think it is undervalued relative to its proven business potential and long-term prospects. That is my thought about ITV, for example. But other investors may look at the same share and consider it a potential value trap.
Long-term mindset
By investing for the long term, I think I can find some situations where a share is significantly undervalued.
That might be because it is in a sector that is temporarily out of favour or simply has a cyclical business trend. It might be because a business has stronger growth prospects than is commonly understood, for example because of a hit new product. It could be because changing customer behaviour will boost an existing business.
Whatever the reason for their valuation, if I can buy cheap shares in great businesses, over time, hopefully I can build wealth.
