The Little Book of Value Investing Chapter 2: Finding Bargains

"You are looking for companies that have temporarily stumbled, companies that are in out-of-favor industries, or companies that are simply ignored." — Christopher Browne

The Investment Context

If value investing is about buying dollar bills for 66 cents, the obvious question is: where do you find them? Browne provides a roadmap for hunting bargains, emphasizing that you will rarely find them in the headlines of the financial news.

Bargains exist where other investors refuse to look. They are found in boring industries, in companies facing temporary scandals or setbacks, or in small companies that Wall Street analysts simply do not have the time to cover.

The Wall Street Translation

Wall Street analysts are heavily incentivized to recommend stocks that are already going up. They rarely recommend stocks that are cheap and hated, because it damages their short-term reputation if the stock doesn't bounce back immediately.

1. Low Price-to-Earnings (P/E): The simplest metric for finding value is a low P/E ratio. If the average stock in the market trades at 18 times its earnings, a company trading at 10 times its earnings is, on the surface, a bargain.
2. Low Price-to-Book (P/B): Book value is the net asset value of a company (assets minus liabilities). If a company is trading below its book value (a P/B less than 1.0), you are essentially paying less for the company than the value of the hard assets it owns.
3. The "Meat and Potatoes" Approach: Browne prefers boring, predictable businesses. A company that makes ball bearings or sells insurance might not be exciting, but its cash flows are highly predictable, making it much easier to calculate a reliable intrinsic value.

Actionable Trading Rules

1. Screen for the Unloved: Use stock screeners to find companies in the bottom 20% of the market in terms of P/E and P/B ratios. This is your hunting ground. Most of these companies deserve to be cheap, but a few will be unfairly punished bargains.
2. Look for Temporary Problems: If a great company suffers a solvable, temporary problem (e.g., a localized supply chain issue, a minor regulatory fine), the stock price will often crash as short-term traders panic. This is the perfect time for the value investor to step in.
3. Avoid Value Traps: A stock is not a bargain just because the price went down. If a company's fundamental business model has been permanently destroyed by new technology (e.g., Blockbuster video), it is a "value trap," not a value investment.