Holiday shopping for investors

The hardest part of value investing is understanding the difference between buying a wonderful company at a fair price and buying a fair company at a wonderful price. To illustrate the difference, let’s go shopping…

Many investors understand “value” as buying a dollar for 80 cents. It usually involves looking for companies that have fallen out of favour for one reason or another. In a certain sense, it’s like the discount bargain bin in a department store, full of last year’s fads and some damaged merchandise. Unfortunately, most of the companies are in the bin for a reason; they’ve got earnings problems, debt problems, asset impairments, and other nasty sounding stuff, so buying them can turn that 80 cents into 60 cents fairly quickly. Some of the companies will make it through, but it’s going to take a lot of volatility to be successful. Possessing the stoicism of an oak tree is crucial.  

Most of us aren’t built to handle that.

A far more reasonable approach to value investing is to stop demanding the dollar for 80 cents. Cast in a new light, a relative value investor looks for the highest quality merchandise on the top floor of the department store, and pays a dollar for it. So instead of capitalizing on a mispriced 20 cents in the bargain bin, our relative value investor seeks a 20 cent gain from continuing growth and appreciation. These types of value companies are identified by strong brands, strong earnings, strong balance sheets, and less risk. They will not necessarily be available at a discount, but then again they shouldn’t be. Naturally, investors should be willing to pay more for higher quality assets, but not too high. On the whole, these value companies are far more likely to succeed in delivering positive returns with less volatility than bargain bin shoppers are used to.

Canadian shoppers have had ample opportunity to see both types of value in action. The decline in gold companies from 2011 to present, followed by the more recent decline in energy companies is today an example of bargain bin value. Many of these companies are selling at a discount and require significant fixing to realize their value. On the other hand, some Canadian consumer companies today are an example of relative value. They’re not selling at a discount, but are creating their own value through consistent earnings growth backed by strong assets.

With the holiday shopping season upon us, you want to buy a present that will be appreciated. Sticking with high quality and being choosy is sure to please. Remember that the stuff in the bargain bin is there for a reason. 

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.