There is no single way to outperform the market easily or consistently.
The investors that have outperformed in recent years have focused on quality and growth. Shares that are technology-related in-particular have performed very well. Just think about all those ‘A’ tech shares like Altium Limited (ASX: ALU), Appen Ltd (ASX: APX), Afterpay Touch Group Ltd (ASX: APT) (and Apple, Alphabet and Amazon).
But these days all those growth names are extremely expensive with their price/earnings ratios. It could be risky to buy them at these prices.
Is the answer to look for shares with low price/earnings ratios? I’m not sure about that either. Low p/e ratios could signal low quality.
Warren Buffett has said in the past that if he were managing a much smaller pool of money and he was trying to outperform he would look for value arbitrage opportunities. In other words, he would try to find assets that are cheap compared to their value – their price to book valuations are low, or the share price is cheap compared to the balance sheet.
He may have been referring to cheap bonds that he could make money with, but businesses that are trading cheaply to their balance sheet could also be a very good way to beat the market if they quickly trade closer to their book value, although there’s no guarantee that discount will close up.
If you like the business anyway then being able to buy it for less than it’s worth is an attractive idea. Some of the businesses that are likely trading at double digit discounts to their balance sheets that interest me are: Urb Investments Ltd (ASX: URB), Brickworks Limited (ASX: BKW) and NAOS Small Cap Opportunities Company Ltd (ASX: NSC).
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Tristan Harrison owns shares of Altium and NAO SMLCAP FPO. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Pro Medicus Ltd. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Altium, WiseTech Global, and Xero. The Motley Fool Australia owns shares of AFTERPAY T FPO and Appen Ltd. The Motley Fool Australia has recommended Brickworks and Pro Medicus Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.