Best Places to Hunt for Cheap, Great Companies
Most of the time when I look at quality stocks, I find that they are too overpriced for me, and I pass… only to see them continue going up and compounding over time.
“Overpriced” companies are typically priced the way they are for a reason: they are great businesses. They have high margins, good cash flows, and the ability to reinvest their cash flows with high rates of return.
But I just have a hard time buying high quality companies, as I’m constantly nervous that I bought them at too high a price when the market is factoring in all the “blue sky” potential in the business, leaving little margin of safety.
Therefore, I usually end up buying deep value stocks, which are usually considerably inferior businesses but are selling low compared to liquidation value or EV/FCF. There’s nothing wrong with that strategy, but it usually has a shorter “shelf life” and thus requires more market timing, which I don’t like.
Now, what if I could buy high-quality companies and hold them for a long time, allowing superior management teams and businesses that I believe in to compound value but buy them at a great price?
In my opinion that’s the best of both worlds, as I am then able to find quality companies that I can hold for a long time without the stress of having paid an overly optimistic price for them or having bought some marginal company that might do well for some time but then at some point won’t.
These are rare opportunities and typically arise from market distress, such as a stock market crash, or from a misunderstood, temporary setback with a fundamentally good company. When these opportunities come along, it can be a great time to invest.
Another place to look for great companies is in sectors or economies that have been in a prolonged bear market, where investors are throwing the good companies out with the bathwater. Right now, we have a couple of areas that are prime hunting grounds for great companies that might be selling too cheap.
One such sector is commodities. Commodities go through massive boom and bust cycles, and these companies can go from incredibly depressed to very profitable in a short period of time.
But commodity producers themselves are typically not great businesses. They have no “moat,” have irregular cash flows, and have inconsistent reinvestment opportunities. I do invest in these, but they are typically something to buy close to the bottom of a cycle and sell on the way to the top.
Another area I have started focusing more on recently is emerging markets, especially emerging market economies that have favorable fundamentals and are net exporters of essential commodities.
There are great companies to be found there that might be doing okay now, but in a bull market in commodities, they could be incredibly profitable. Many emerging market economies become flush with cash in commodity bull markets, and it’s great to be a company catering to their populations then.
In summary, these are our three favorite ways to find cheap, great companies:
Distressed markets
Temporary setbacks with a fundamentally good company
Sectors and economies that have been in a prolonged bear market
The last category is where we are finding the best opportunities now. I will be writing up some more ideas in the near future, so stay tuned!
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Disclaimer: This article is for informational purposes only and does not constitute investing advice. Please consult with a qualified financial advisor before making any investment decisions.
