Thai VI

Selecting Unpopular Stocks

If an investor is to do better than average, Graham argued that his or her investment policies should not be popular.

He believed that most Wall Street professionals tend to seek out stocks with the best growth prospects and to ignore other stocks. This bias causes unpopular stocks("ม้านอกสายตา") to become undervalued and good buys.

Still, profiting by buying an unpopular or neglected stock, or selling short a popular, overvalued stock is no easy road to riches. "Buying a neglected and therefore undervalued issue for profit," Graham cautioned, "generally proves a protracted and patience-trying experience. And selling (short) a too popular and therefore overvalued issue is apt to be a test not only of one's courage and stamina but also of the depth of one's pocketbook."

Four activities that enterprising investors tend to engage in are:

1. Buying in low markets and selling in high markets. This is an extremely difficult practice and can lead to speculation. Investors can limit this through the flexible 25% to 75% weighting that can be given to stocks.
2. Buying carefully chosen growth stocks. There are two problems with this approach. Growth stocks sell at a premium to account for its future growth prospects. So even if the company were to satisfy the market’s future expectations the share price may still not rise. Another problem is that one could be wrong and the company may not achieve the expected growth targets. After all, no company can out pace the growth of the economy forever. There are many investment growth funds, but very few of them have consistently earned a rate of return above the market indexes. Therefore, it is unreasonable to expect most individual investors to beat the indexes, where most professionals have failed.
3. Buying bargain issues of various types.
4. Buying into special situations.

Value Play #2. Purchase of Bargain Issues
A bargain issue is one which appears to be worth at least 50% more than the current price. There are two methods of determining the intrinsic value:

1. Appraisal Method - estimate future earnings and then discounting them back to find the value per share.
2. Private-Owner Valuation - estimate the value of the company to a private purchaser. This focuses more on the net realizable value of the assets. Net Working Capital is also important.

In identifying companies for further analysis, focus on those that have (1) currently disappointing results and (2) protracted neglect or unpopularity. These are most likely to be undervalued.

You need more than poor results. You are looking for reasonable stability in the past and reason to believe that there is sufficient size and strength for the company to recover in the future. Look for large, prominent companies selling below past average price and past average price/earnings multiple.

In some cases, the share price is valuing the company at less than its net working capital (current assets less current liabilities) and so a purchase of the company at that price would mean the fixed assets are being purchased for free. The long term trend will likely be for the price to move up to a value in excess of the net working capital, to take into account the net assets.

Often, companies that are secondary in an industry are more likely to be undervalued than the industry leader. These can provide a great opportunity, as secondary companies often have high dividend returns, and a bull market will ordinarily be most generous to low-priced issues like these. Additionally, acquisition is a more common possibility in consolidating industries, which would lead to a substantial premium over the purchase price.