Even Buffett Isn't Perfect by Vahan Janjigian

Author:Vahan Janjigian
Language: eng
Format: epub
Publisher: Penguin Group USA, Inc.

Buffett Likes Undervalued Stocks Best

Warren Buffett is one of the richest men in the world. But he has garnered a reputation for being cheap. He was once asked why he wears such cheap suits. As he often does, he responded with humor, assuring his questioner that his suits are not cheap even though they may look cheap on him.

Although he can afford to buy anything he wants, Buffett prefers to lead a modest life. He drives a modest car and lives in the same relatively modest house he bought decades ago. But his reputation for being cheap is undeserved. Buffett certainly appreciates value, but he is not cheap. As a smart consumer and a smart investor, he knows there is often a big difference between price and value. Just because something is cheap does not mean it provides good value. On the other hand, value can sometimes be found in an item that appears expensive. Just as Buffett looks for value when he is shopping for a car with his own money, he looks for value when he is shopping for stocks with Berkshire’s cash.

This certainly makes a lot of sense, but not everyone behaves this way. Those who do are not easily taken advantage of. They often find great bargains. When you go shopping for a new suit, would you not rather pay as little as possible? If you know one store is selling the same suit for $100 less than another store, would you not be willing to go at least a little out of your way to save some money? The same is true with investing. It is always best to pay as little as you can when buying any asset. But just as Buffett does not buy cheap suits, he is not going to buy a stock simply because it has a low price. He understands that sometimes it makes more sense to pay a premium for a stock with better prospects, even if that premium makes the stock appear expensive. The point is that while it may be true that Buffett has a general preference for value stocks over growth stocks, what he is really looking for is stocks that are undervalued.

This may sound like a rather subtle and unimportant difference, but it is critical to understanding Buffett’s investment philosophy. Never confuse a value stock with an undervalued stock. As explained earlier in this chapter, a value stock is traditionally defined as one that has low price multiples. An undervalued stock, on the other hand, is one that is selling for less than it is worth. A value stock might be undervalued, but it could be overvalued. Likewise, a growth stock could be under- or overvalued. The point is that it is not important which category, value or growth, a stock falls into. The only thing that really matters is whether the stock is selling for more or less than it is worth. This happens because the market does not always properly price stocks.

As we

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