In my article yesterday, I noted that bear markets are often fertile grounds for finding undervalued businesses. In the absence of bear markets, value investors seek to exploit other market environments that can occasionally offer a gem or two. Let's examine two such environments.
Unfavorable industry in a generally optimistic market
While a rising tide lifts all boats, the occasional baby can be thrown out with the bathwater. Currently in the U.S., this seems to be the general state of affairs. The indexes are near their all-time highs, but any business currently involved with homebuilding, mortgages, or credit extension feels like the unwanted stepchild.
For the most part, the market has it right. Though it's trading at $16 with a supposed forward P/E of 8, I still don't care to own Countrywide Financial
Several years ago, when Warren Buffett was buying shares of PetroChina
So while most homebuilders and mortgage lenders may still be overvalued, the strongest companies in the group will find themselves in a position to pick up market share with very little in the way of capital expenditures. Such situations can often lead to what Mohnish Pabrai refers to as "heads I win, tails I lose a little."
Favorable industry in a generally unfavorable environment
This area of investing should only be exploited after the most rigorous research, and investors must demand a higher margin of safety when looking to invest. These are companies usually operating in foreign countries or hostile environments.
As such, they are loaded with uncertainty, thereby exposing them to extreme price-to-value inefficiencies. More often that not, these businesses offer no value. Occasionally, an exception can be found.
Years ago, a small distributor and producer of spirits in Poland, Central European Distribution Corporation
A similar situation seems to be brewing with Harvest Natural Resources
Nonetheless, you should never make an investment until you completely understand what you are doing, regardless of who owns shares in the company. If you don't understand it, move on -- it is detrimental to step outside of your circle of competence. Develop a sound search strategy, remember to stay within your circle of competence and not to worry about its size, and you'll do fine.
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