With the stock market reaching new all-time highs lately, a lot of investors are stuck with the question if they continue to invest in a possibly overvalued market. It’s an important question that I struggled with as well when I just began investing.
Basically, the short answer to this question is a full-blown ‘Yes’. This doesn’t mean you should just blindly hop aboard the train of market optimism. Rather, it’s a much better idea to adopt the ways of Warren Buffet and Charlie Munger.
Highly successful value investor Mohnish Pabrai summed up perfectly how Warren Buffet and Charlie Munger approach investing in an overvalued market :
“Warren and Charlie have a very simple system. They are not trying to hoard cash. If a sensible opportunity shows up, they will simply put the cash to work. They are not particularly concerned with what happens in the economy or the country in the short term or even in the long term. Rather, they execute solely based on the understanding of the business.
If you analyze Warren’s purchase of BNSF Railway, it reveals his understanding of the infrastructure of the railroad industry. The company was sold to him at such a high value in terms of its true intrinsic value that it did not matter what happened in the economy in the short term. Now, BNSF is worth three to four times more than what Warren paid for. Warren and Charlie spend the most of their time in figuring out the business.
I truly believe that they understand a lot of the macro, but that the micro trumps the macro in their perspective. They are seeking to purchase businesses well below the intrinsic value with strong staying power.”
Mohnish Pabrai and Warren Buffett
The main take-away from Mohnish Pabrai’s quote is that value investing is all about analysing businesses and not the economy or stock market in general. Great opportunities exist in all stages of the economic and stock market cycle. It just requires a little more work to find them in an overvalued market, but the extra work is well worth it.
Of course for us as value investors it’s much ‘easier’ (for a lack of a better word) to invest in times of a stock market correction or crisis, since almost all of the stocks on our wish-lists are undervalued at those times. And that’s when you should aggressively take advantage of the sale that’s going on.
As Warren Buffett said : “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble”
If the stock market is at all-time highs, this shouldn’t keep you from investing. As a value investor I don’t care too much about the general stock market. I primarily focus on analysing businesses and look for value investments. Even if these companies are overvalued I can still put on my wish-list and wait until they hit my price target in the future.
Where To Look
To increase your chances of finding a great value investment I advise you to look at stock market sectors that are currently unpopular, because that’s often where the best value opportunities can be found. For example, from 2015 – 2016, while the general stock market was in a bull market, oil & gas companies were getting hit hard and their stock prices tanked because of low oil prices.
At those times, long-term value investments can be made, even though the market in general is overvalued. So if you want to increases your chances of finding a great value investment in an overvalued market, look at those sectors that are temporarily depressed.
Another great way to look for value investments in an overvalued market is by looking for companies that are in temporary trouble. Temporary troubles can cause major bargain-hunting opportunities (These troubles must truly be temporary and not structural).
An example of an investment I made in a temporary troubled company was Volkswagen. Volkswagen was involved in a huge scandal in late 2015, which send their stock price down by more than 50%.
I saw these troubles as temporary in nature and not damaging for the long-term (+- 10 years) profitability of Volkswagen. So I decided to invest in Volkswagen and since then, the stock has increased more than 50%.
Yes, it will be a bit harder to invest in an overvalued market, but opportunities to make incredible investments are always out there.