What makes something cheap? Is it just the price? I don’t think so: even a low price can be too expensive for something of very bad quality. I see cheapness as about value. So when looking for cheap shares, I am hunting for great quality businesses with a price tag below what I think they merit.
I can hardly claim any credit for such an approach. It is one used by many investors, including billionaire Warren Buffett. As Buffett has said in the past, “price is what you pay. Value is what you get”.
With stock markets on edge this month, some share prices have tumbled. But I think many of the businesses concerned have not seen their underlying commercial prospects worsen. That offers me the chance to scoop up cheap shares in iconic UK names. That is exactly what I have been doing in the past several weeks. I remain on the hunt in the current choppy market!
How to find cheap shares
So, what approach do I take when sniffing out bargains?
I stick to what I know. Like Buffett, I think that increases my ability to know what I am judging. He refers to this as staying inside one’s circle of competence.
I look for businesses that I think have a strong competitive advantage within an industry I expect to see ongoing customer demand. For example, lately I have been adding to my holding of J D Wetherspoon. I think its existing network of pubs and well-known value proposition help set it apart from rivals.
Then I consider what I think a business will be worth over the long term. Even within my circle of competence, this can be challenging. After all, risks can be hard to assess and size.
Sometimes, I find it so hard to value a company that I simply give up. Possibly Hipgnosis is a bargain, but I simply do not feel qualified to judge. I do not fully understand the long-term outlook for song royalties.
Hunting for value
When I feel I can value a company, I then look to see whether its shares are cheaper than my valuation, allowing for the opportunity cost of tying money up in it over time. This is basically a form of the method known as discounted cash flow valuation.
I can make mistakes, though, and some risks may end up being more costly than I expect. So like Buffett, I aim to invest with a margin of safety.
For me, cheap shares are not ones that sell for slightly less than I think they are worth. Instead, they are what I see as screaming bargains: they trade at a significantly lower price than I think they merit.
Pouncing on bargains
Sometimes I can see few or no such bargains in the market.
But at other moments, share prices fall even for companies with strong prospects. I have been buying Wetherspoon because I think it is a bargain at the moment. I am hunting for other cheap shares I can add to my portfolio during this time of market turbulence.
