Investors who’ve adopted a buy-and-hold undervalued stocks strategy have generally been successful in obtaining chunkier returns. Arguably, one of the best examples of this would be Warren Buffett. He’s averaged a 19.8% average annualised return since the 1960s – that’s nearly triple what the FTSE 100 typically generates.
Of course, this is far easier said than done. Shares may be cheap for a good reason. And a bargain today may later be uncovered as a trap that ends up destroying wealth instead of creating it. So, with that in mind, let’s explore some sensible practices to employ when hunting for buying opportunities in 2024 and beyond.
Where to start
Relying on relative valuation metrics like the price-to-earnings (P/E) ratio can eliminate many fantastic deals from consideration. Instead, I prefer to follow in Buffett’s footsteps and carefully analyse each firm. That way, I can build an informed forecast that can be fed into a discounted cash flow model.
This approach isn’t without its limitations. And the biggest disadvantage is that it’s exceptionally time-consuming, and not everyone has the patience for it. This is especially true after investing countless hours estimating the intrinsic value of a firm only to discover it’s not actually trading at an attractive discount.
Fortunately, the probability of finding an undervalued stock can be increased by starting a search in the right place. Focusing on popular stocks covered by financial media headlines and online articles is likely to result in a dead end. After all, when all eyes are on a business, more analysts are following it, causing any potential buying opportunities to disappear quickly.
That’s why I like to start searching in industries that few people are paying attention to. Or better yet, the sectors that investors are actively avoiding. One example of the latter right now would be real estate, in my opinion.
With interest rates rising to multi-decade highs, property values have been tumbling along with stock valuations. But in many cases, rental cash flow remains robust. And with research groups like Savills predicting property prices to start climbing again in 2025, the discounts may soon be disappearing.
Quality is crucial
Finding undervalued stocks to buy and hold can end up underperforming if quality is not properly considered.
Looking again at Warren Buffett, his early strategy was to focus on finding the cheapest businesses, good or bad, that still had a tiny amount of value left, which other investors were overlooking. It wasn’t until the late Charlie Munger entered the picture that Buffett started thinking long term. And that meant quality became paramount.
Analysing the quality of a business is a bit of a subjective process. That’s why it’s easy to find a seemingly terrific business have plenty of sceptics, or vice versa. But apart from having solid financials, some of the most successful businesses in the world today share some common qualitative traits.
In my opinion, the most important factor I look for is the presence of competitive advantages. A business that can systematically stay ahead of its competitors, whether it be through higher margins or a superior product, is more likely to capture a greater market share. And buying a future industry titan at a discounted price today could potentially lead to Buffett-like returns in the long run.
