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This year has seen stock market volatility on both sides of the pond. Many stocks suddenly look cheap.
In such a situation it may be tempting to plunge into the market and start buying immediately. But is that a wise way to try to build wealth?
Real cheapness is a goal, not an assumption
Especially at a time like this when markets are in turmoil, it helps to remember what we are really talking about when we talk about cheap stocks.
Just because a stock’s price has fallen doesn’t mean it can’t continue to fall. Some stocks are falling and looking really cheap – but keep pulling back.
Look at stock price charts Ocado, Aston Martinor Diageo a few years ago (to name just a few).
There were many times when each looked like a bargain compared to its previous price – yet it continued to head south.
The issue here is that cheapness is not subjective. Just because something costs less than before doesn’t make it cheaper.
Instead, I see cheapness (and value) as the goal.
Am I paying less for something than I think it’s worth, when I factor in the opportunity cost of committing my money to it and allow myself a margin of safety when I value it?
As billionaire Warren Buffett says, price is what you pay, but value is what you get.
This market contains bargains – and value traps
So, I’m not in a rush to invest just because the markets have been going down for the past few weeks.
The current geopolitical stability and its impact on oil prices and inflation is wreaking havoc on some businesses. Indeed, that has already been reflected in recent announcements from companies whose trade might seem far removed from the Middle East’s oil markets, such as the owner of a pub. JD Wetherspoon.
What might that mean for investors? Some stocks that look cheap right now may end up being a drag depending on what happens in the economy in the coming months.
But some can end up looking like real goods.
I can’t wait to see the prices go down further. Instead, when I’m looking for stocks to buy, I ask myself the same question I always do: can I buy what I see as a good business at an attractive price?
I stick to what I think is the benefit
For example, one stock I thought was a bargain when I bought it a few months ago is a yoga clothing retailer. Lululemon Athletica (NASDAQ: LULU).
After the purchase, it went up and I was sitting on paper profit. But the share has sunk again and my position is now worth less than what I paid for it. However, I have no plans to sell as I think Lululemon remains a long-term investment.
A weak economy and low consumer confidence can hurt discretionary spending. Lululemon’s North American business was already struggling to keep up with fashion trends, so the company is facing many risks right now.
Long term, however, its strong brand, reputation for product quality (with a well-publicized anonymous slip), and large customer base are strengths. In addition, sales to other countries are increasing significantly.
