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Reasons I prefer Bargain Hunting to Momentum investing:
Buying bargain stocks, frequently all I am asking the stock to do is get back to its average valuation multiples. The momentum player is often asking a company to maintain an unsustainable rate of growth in order to support unrealistic valuation multiples.
As an example from my SLO portfolio, BJ Services (BJS, an Oil & Gas Services provider), currently trades at a substantial discount to its own historical averages on P/E, P/B & P/S. It also trades at a discount to its peers on the same metrics. If BJS traded at the same P/E as its peers, the stock would increase from 26.37 to 48.99. I did the same computation for P/B, P/S and P/CF, averaged the results, and BJS on that basis would trade at 38.69, a 40% increase.
A stock that is trading at its bottom can't go down much, often there is margin of security in price/book or price/cash flow. On the other hand, a momentum stock trading at, for example, a Price/Sales ratio of 12 has a very long way to go down.
Cincinnati Financial (CINF, a Property & Casualty Insurance Co.) was added to my SLO portfolio at a price to book value of .94. At its current price of 42.75, I have a 14% profit, and the P/B at 1.1 is well less than the peer group at 1.5. The assets behind their book value include not only the usual bonds but also a substantial amount of stocks, mostly stable dividend payers.
The value investor has better options if his position develops unfavorably. If my treasure declines in price, I usually have a dividend to console me, and I can hold through or average down, confident of value. If a momentum stock goes down, the investor's options are a) wishing he had used a stop loss b) taking a nice tax loss or c) doubling down, hoping a greater fool will materialize.
Olin (OLN, Olin Brasss, Winchester Ammunition, & Chlor Alkali Chemicals) is included in my SLO portfolio and I have great hopes for it. It pays a dividend of .80, yielding 3.72% at a price of 21.51. If OLN's price goes down, the dividend, which is regarded as secure, will provide me both income and protection. I will have the option of holding through the dip, while I monitor results to determine if my expected scenario is going to occur.
The value investor is sometimes able to get large returns with very little risk.
Tessco (TESS, a wireless distributor) added to my SLO portfolio at a P/B ratio of 1, has made money every year for the past 10 years, has negligible long term debt on its balance sheet, and closed 2007 with a current ratio of 1.6. Every year from 2001 to 2006, it was possible to buy it for less the 1 x Book and sell it for more than 1 X book. The risk involved would have been negligible. TESS now trades at a P/B of 1.44, giving me a 50% increase in a matter of weeks. I don't think it is cast in stone that risk and reward have to be proportionate.
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