Warren Buffett’s annual letter to his shareholders gets a lot of attention, because it gives us an insight into the mind of perhaps the greatest investor ever. In his most recent letter, he talked about how difficult it has been in finding potential acquisitions that weren’t overpriced.
Buffett is a big bargain hunter, and many investors lack the patience to simply sit back and wait for a really good buy, and instead they will settle for the best one that is available.
What makes a stock a good value buy?
There are many ratios and metrics you can use to find stocks that are reasonably priced, but that should only serve as a starting point. For example, stocks that are trading below book value could be attractive buys, but investors should also consider the reasons behind the low valuations.
Tahoe Resources Inc. (TSX:THO)(NYSE:TAHO) for instance, is trading well below its book value, but the company has struggled recently and its operations in South America are a big question mark.
Meanwhile, Corus Entertainment Inc. (TSX: CJR.B) is another stock that has dropped well below book value, as it has seen its share price fall victim to what I would consider to be a big market overreaction, as the company still has a sound business model and can very likely rebound from a disappointing Q1.
Ratios can help you narrow in on stocks, but you also need to consider other factors as well.
Importance of a strong moat
Moat is a word that Buffett likes to use often to help identify a company’s staying power and its long-term potential for growth. A company that doesn’t have a big moat and lacks a competitive advantage could easily be copied or undercut in price, which would threaten its business.
A good example of a lack of a moat is in the marijuana industry. While Canopy Growth Corp. (TSX: WEED) is making a name for itself with some key supply deals and trying to gain market share, the cannabis company doesn’t have a big competitive advantage over new entrants.
This is why there are many new cannabis companies being listed on the TSX and on the venture exchange, because of the low barriers to entry and the ease of a new company to start growing and selling pot.
The danger is that if the day comes when pot is legalized at the federal level, that a big public company could enter the space with significant resources and takeover the industry, and there would be little that a company like Canopy would be able to do about it.
Without something unique about its products or services, a company’s moat will be minimal, and regardless of what multiple it trades at, it’ll still be a risky buy.
Bottom line
While there are many overvalued stocks on the TSX today, there are still value buys that can be found. However, it’s important to consider more than just numbers when it comes to investing, as there are many significant factors that can’t always be quantified.
