Stock Market Investing - Looking in the trash

I wrote a post several months ago about an investment strategy that involved buying into shares that had crashed.

Warren Buffett's investing theory

Warren Buffett referred to this strategy as Cigar Butts. This was because he likened the strategy to searching on the ground for used cigars that have one remaining puff. If you need a nicotine fix and have no money for cigars or cigarettes then picking up a few remaining cigar butts throw away by other people may give you the fix that you need. It's not pretty, in fact it's extremely dirty work but it can be profitable. Likewise, hunting around for once great companies that have fallen on hard times could be equally, if not more profitable. Investing in these dirt cheap shares and selling after making a quick return was how Buffett made a portion of his fortune. 

Buffett's mentor Benjamin Graham

Mentor to Buffett, Benjamin Graham recommended that if you wanted to find cigar butt-like shares then you should look for those Companies whose current assets are greater than their total liabilities. Whatever this net figure is if it is equal to or slightly greater than the total market capitalisation of the Company then you've found a bargain. However, Graham caveats this by suggesting that these sorts of businesses will have a very depressed price for one or more particular reasons. As such he suggests that you should only buy into these sorts of Companies when there are a number of them available.

At this point I feel the need to provide some realism. These sorts of shares are rare particularly in a growing stock market such as ours. The time to buy into these sorts of shares are when the whole market is depressed, as it is at this time that bargains become available. Nonetheless, if you scan the business news every day you may be able to spot Companies that have fallen out of favour. It is these news articles that I take as an indicator that I should take a look at that Company.

Last summer Britvic plc was in the press for having produced faulty products. It had produced 12million faulty bottle tops for it's famous Fruit Shoot bottles. As a result the share price fell 15% in one day. Followed by further falls by a couple of percentage points. The large price falls brought the company to my attention. Britvic had a diversified range of drinks other than Fruit Shoot including it's successful Robinsons brand. The company produced plenty of cash and a healthy balance sheet. As a result, I invested and was quickly rewarded with a 30% growth in the share price only a few months later. Unfortunately, due to external forces I was forced to sell at a healthy profit. However, if I was still holding those shares today I would have virtually doubled my money. C'est la vie!

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1 comment

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