In this market, I follow Warren Buffett in picking up cheap stocks!

Image source: The Motley Fool

What makes something cheap? Is it just the price? I don’t think so: even a small price can be too expensive for something of very poor quality. I see the cheap as about value. So when I’m looking for cheap stocks, I’m looking for high quality companies with a lower price than I think they deserve.

I can hardly claim credit for such an approach. This is the one used by many investors, including billionaire Warren Buffett. As Buffett has said in the past, “the price is what you pay. Value is what you get”.

With stock markets on edge this month, some stock prices have fallen. But I think a lot of the companies affected haven’t seen their underlying business prospects deteriorate. It offers me the chance to buy cheap shares in iconic British names. That’s exactly what I’ve been doing for the past few weeks. I stay on the hunt in today’s turbulent market!

How to find cheap stocks

So what approach should I take to sniff out bargains?

I stick to what I know. Like Buffett, I think it increases my ability to know what I’m judging. He refers to this as staying within his circle of competence.

I look for companies that I believe have a strong competitive advantage in an industry where I expect to see continued customer demand. For example, recently I added to my portfolio of JD Wetherspoon. I think its existing network of pubs and well-known value proposition helps it stand out from its rivals.

Then I consider what I think a business will be worth in the long run. Even in my circle of competence, it can be difficult. After all, risks can be difficult to assess and measure.

Sometimes I have such a hard time evaluating a business that I just give up. Maybe hipgnosis is a good deal, but I just don’t feel qualified to judge. I don’t fully understand the long-term prospects for song royalties.

Value hunting

When I feel I can value a company, I then look to see if its stock is cheaper than my valuation, taking into account the opportunity cost of tying up money in it over time. It 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 expensive than I thought. So, like Buffett, I aim to invest with a margin of safety.

To me, cheap stocks are not ones that sell for a little less than I think they are worth. Instead, they’re what I consider gaudy bargains: they’re trading for significantly less than I think they deserve.

Jump on good deals

Sometimes I can see little or no such bargains in the market.

But at other times, stock prices fall even for companies with strong prospects. I bought Wetherspoon because I think it’s a good deal at the moment. I’m looking for other cheap stocks that I can add to my portfolio during this market turmoil.



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