Many years ago, I read Contrarian Investment Strategies by David Dreman, a value investor. His message, which remains relevant today, was as follows: “Over the long term, neglected, undervalued and unpopular stocks often offer the best return prospects.”
Dreman favored stocks with low price-to-earnings (P/E) ratios, arguing that these securities offered higher return potential and lower downside risk than those with high P/Es. Indeed, companies whose shares are inexpensive are often subject to low financial expectations, whereas those with high P/Es face elevated expectations. In both cases, investors risk making mistakes by extrapolating a company’s recent performance: companies with low expectations may outperform forecasts, while those with high expectations may disappoint.
However, it is often uncomfortable to own stocks of companies facing low expectations. These are generally businesses experiencing difficulties, whose financial performance leaves something to be desired, or that are perceived as carrying significant risks.
At present, this appears to apply to many companies operating in industries that could be affected by artificial intelligence (the list of such companies grows longer every day): software, consulting services, data providers and database access providers, etc.
It also seems that stock markets are “extremist” in their assessment of the potential and risks related to AI. On one hand, they appear obsessed with the growth prospects of AI-related companies, seeing only the enormous potential without paying attention to the risks. In many other cases, particularly for software companies, the focus seems to be solely on the risks related to AI, while ignoring the potential positive spillover effects.
I firmly side with David Dreman. Long-term investment opportunities are found among neglected and overlooked stocks — that is, those with relatively low P/E ratios.
That said, investors who favor such securities must often arm themselves with patience. In the short term, it is often more “comforting” and profitable to invest in popular stocks, even though this is not necessarily the most rewarding strategy over the long term.
It has never been said that value investing was easy or effortless.
Philippe Le Blanc, CFA, MBA
Chief Investment Officer at COTE 100
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