Image source: The Motley Fool
2024 has seen a new high in the FTSE 100 and rising indices on the other side of the pond. Despite that, I'm still looking for cheap stocks to buy for my portfolio.
I will continue doing it in 2025. That's how it's done.
First things first. What exactly is it? is a bargain?
Perhaps you could buy a stock for less than its assets are worth. That's the approach taken by Warren Buffett early in his career. Surprising as it may seem, some stocks are trading for less than their assets are worth even now. In fact, when investors talk about investment trusts trading at a discount to net asset value, that is exactly what they are referring to.
But I'd rather find stocks to buy that are a bargain compared to what I expect them to be worth over the long term.
Step Two: Find Brilliant Businesses
That's why I look for companies that I believe have a sustainable competitive advantage in a field where I expect to see high long-term demand.
There are thousands of companies listed on the UK and US stock markets. Most I don't understand them and, in many cases, I don't even properly understand the area of business they are in.
So, I stick to my “circle of competence“, as Buffett calls it, and focus on businesses that I think I can handle.
Step three: detect a valuation gap in my favor
However, even a brilliant business can be a terrible investment. If I overpay for a stock relative to its intrinsic value, I could be in a situation where my share is worth less than what I paid for it, even as the company continues to grow its earnings.
That's why I look for situations to buy stocks at a price significantly lower than I think they are worth.
Sometimes I'm wrong. For example, a price drop following a profit warning can sometimes appear to be a buying opportunity, but then turns out to be a harbinger of a company in trouble. What seems like a bargain may be a value trap.
That's why I focus on companies with proven business models that I believe have strong long-term prospects.
Putting theory into practice.
As an example, this year I have invested in crocodiles (NASDAQ:CROX).
After skyrocketing 162% in five years, it might seem like Crocs is anything but a bargain. In fact, however, the stock trades at a price-to-earnings ratio of less than eight.
The footwear market is here for the long haul, if you'll pardon the pun. Crocs has a strong brand, distinctive design, and competitive manufacturing costs. By expanding its range, I hope it has overcome what I see as a key risk: that its shoes will fall out of favor with buyers as the fickle winds of fashion blow.
Risks remain that help explain the low price, such as continued sales challenges for the company. Hi, friend brand.
But when I look for stocks to buy, my focus is on long-term potential, not short-term sales trends. I will continue to apply that approach as I scour the market for bargains heading into 2025.
