If there's an upside to the rough market investors have had in 2022, it's that lower stock prices make companies' shares more attractive from a value investor's perspective. When all is said and done, stocks are nothing more than partial ownership stakes in businesses. If you recognize that the value of a business is based on the cash it generates over time, you can then use that information to estimate a fair value for the company's stock.
In that framework, the lower a company's stock price is compared to its cash-generating ability, the better the value its shares represent and the more of its shares you might be willing to buy. This is how a down market can be a great opportunity for value investors to swoop in and buy solid businesses for reasonable to even downright cheap prices. The mechanics are clear, but there's still a question on timing: Can I time the market with value investing? Well, the answer to that one is a bit more difficult.
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The value investor's curse
One of the biggest risks investors face when investing based on valuation is something that's known as "the value investor's curse." In essence, when a stock starts to look cheap, value investors tend to pounce and buy. Still, the market has no obligation to move a stock up just because its shares look cheap. As a result, value investors tend to get in "early" by buying what look like cheap shares that end up getting even cheaper. That's the value investor's curse.
Over time, those investors are likely to get a decent total return if the company's operations deliver to expectations, but it isn't a quick process. Indeed, as Benjamin Graham -- the man who taught investing to Warren Buffett -- once said, "In the short run, the market is a voting machine, but in the long run it is a weighing machine."
It's a tough dilemma, and it's one for which there's no sure solution. After all, just as the market is under no obligation to bounce back up once a stock looks cheap, it's also under no obligation to keep a stock's price depressed for a long time. Few investing regrets are as bad as missing out on "the one that got away" by not buying a decent company at a great price, yet that's the flip side of a cheap stock that keeps getting cheaper.
Even I've been caught up by the value investor's curse. I've recently been buying shares of mortgage real estate investment trust (REIT) Broadmark Realty Capital (BRMK), based on the company's relatively clean balance sheet for its industry. The company's recent dividend cut brought its payment down to $0.035 per share per month -- a level it called "aligned to distributable earnings."
At a recent market price of $3.78 per share, that new dividend represents a yield of 11.1%. That price offers a potential return -- from dividends alone -- that's about in line with the market's historical long-term total return rate. Should Broadmark Realty Capital's cash flow recover to the point where it can restore more of its dividend, an investor's potential return could increase even more.
Yet I've bought in at higher prices -- prices which I thought were reasonable values at the time based on my assessment of the company's prospects. I still believe in Broadmark Realty Capital's long-term prospects, but rising interest rates and the company's dividend cut have spooked investors, so its shares have suffered.
What can you do about it?
One strategy available to value investors is to buy in thirds. Say you're looking to invest $1,500 into a company that looks like a reasonable value. With the buy-in-thirds strategy, you would invest your first $500 as soon as you identify the stock as looking like it's worth owning. Then, if the stock drops substantially from there, you can invest your second $500. If it keeps falling after that, you can put your final $500 toward it -- all assuming the underlying business still looks like it's worth owning, of course.
That way, if the stock continues to get cheaper, you've given yourself a lower basis than you would have had if you had gone all in, all at once. If the stock stays steady, you can always choose to invest your second and/or third chunk and be no worse for wear. And if the stock skyrockets shortly after you made your first purchase, well, at least you invested something at the time you recognized the opportunity.
And of course, no matter how great a value you think any given company may be, it's important to keep your portfolio adequately diversified. That way, if your investing thesis turns out to be wrong for a given company, the impact from your loss on that company will be limited.
Get started now
While you may not be able to time the market with value investing, you can improve your chances of buying solid companies at reasonable prices using it. Over time, that can add up to a decent total return. After all, market bargains won't last forever, and investors who truly do buy low have the opportunity to see outsize rewards once the market recovers.
Still, to get the most benefit from that recovery, you need to be invested before that recovery takes place. So start seeking out bargains now, and use tools like buying in thirds to give yourself a great chance of participating in the types of returns that value investors strive to earn.
