I read recently that a value investor travels with a stock on its journey from being perceived as truly awful to merely bad. Obviously, this – purposely – oversimplifies the approach. Sometimes ‘truly awful’ proves an accurate assessment or the journey takes the investor in the opposite direction (to extraordinarily atrocious). But even so I think this provides a decent mental model.
As we have noted many times before, the market often extrapolates current news which leaves ‘good’ companies at high ratings and ‘bad’ companies at low ratings. Investors eager to justify having purchased or sold a stock become almost evangelical in their support or dislike of it and sentiment towards the stock becomes extreme. However, often the information driving the share price can prove temporary, irrelevant, misunderstood, incorrect or simply over-discounted. Or perhaps new management can arrive and change the company’s strategy – and consequently the narrative changes too.
That’s the beauty of the value investor’s journey. It’s not that good things always happen to cheap out-of-favour stocks. It’s that if there is good news, the shares are not priced for it and investors can receive a positive surprise. And so, by the time one arrives at ‘merely bad’ perhaps enough has changed for the journey to continue on to ‘distinctly average’ and even ‘better than the market thinks’ and on to the terminus at ‘high quality’.
Of course, as it has been said before, value-investing is simple but not easy. Rather like an expedition into deepest Essex [my neck of the woods] late at night, the stops are rarely well signed. It’s easy to believe you have reached ‘truly awful’ only to discover that you are actually just pulling into ‘merely bad’ and that an extra stop, ‘fairly horrible’ has been added. The value-investing journey can take you to some interesting and challenging places.