Is Valuing A Stock A Waste Of Time?

Should you focus on a company’s quality, rather than its valuation?

saving for retirement

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Value investing is a popular method used to decide which shares to buy and sell. The idea behind it is quite simple: avoid paying too much for a stock. While value investing has been used by many successful investors such as Warren Buffett, there are many other drivers behind a share price other than its valuation. For example, a company’s financial strength, profitability and economic moat. Could they be more important than a company’s valuation in determining the level of capital gains?

Limitations

Clearly, every investment strategy has its flaws. Value investing’s obvious flaw is that the best companies rarely trade at low valuations. This can be applied on either an absolute or relative basis. In other words, investors seeking companies which have a P/E ratio below a specific threshold may never end up buying the very best companies. That’s because they are likely to always trade at a premium due to their strong fundamentals. Similarly, those same companies are rarely cheap compared to sector peers, since they offer either superior return potential or lower risk.

Furthermore, it could be argued that valuing a company means an investor will miss out on significant share price gains. Just as valuing a company can be used to determine whether to buy, it also determines when to sell a specific stock. In other words, if a company’s share price appears to be excessive, value investors may decide to sell up and walk away. However, many investors have profited from overvalued shares becoming even more expensive. Therefore, in such scenarios, value investing may be somewhat limited in its ability to generate outstanding profits in the long run.

Catalysts

In addition, it could be argued that few investors will buy a stock simply because it is cheap. There is usually a catalyst required to drive a share price upwards. This could be in the form of growing earnings, an improving balance sheet, growing dividend, a change in strategy or some other event which justifies a higher share price. This means that buying cheap shares may be insufficient to generate index-beating profits, since catalysts may be required in order to push a company’s share price higher.

In such scenarios, it is likely for a company’s share price to rise no matter what its previous valuation, since it represents a change in outlook or risk profile which the market may seek to reward via a higher valuation. Therefore, whether the stock was cheap or expensive before improved profitability or a higher dividend came along may not have a major impact on its share price.

Takeaway

As with every other investment strategy, value investing has its limitations. It can mean investors miss out on major share price gains, while failing to focus on the key catalysts which could equate to capital gains. However, valuing a company may not be a complete waste of time, since it can lower risk and lead to more consistent returns. Therefore, alongside a focus on a company’s potential catalysts, valuing a company seems to be a worthwhile pursuit.

Just Released! 5 Stocks Under $50 (FREE REPORT)

Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $50 a share.

Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.

Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.

Claim your FREE 5-stock report now!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

golden sunset in crude oil refinery with pipeline system
Energy Stocks

TC Energy: Buy, Sell, or Hold in 2025?

TC Energy is up 30% in the past year. Are more gains on the way?

Read more »

protect, safe, trust
Investing

Stock Market Correction: 1 Safe-Haven Stock for TFSA Stability and Future Appreciation

Fortis (TSX:FTS) stock could be a great way to ride out more tariff volatility in April 2025.

Read more »

analyze data
Dividend Stocks

How I’d Invest $28,000 in Canadian Natural Resource Stock to Amass Personal Wealth

Investing in TSX dividend stocks such as Enbridge can help you earn a passive-income stream in 2025.

Read more »

hand stacks coins
Dividend Stocks

Got $400? How I’d Start Building Income With 3 High-Yield Stocks for the Long Term

These high-yield dividend stocks have a solid payout history, making them compelling investments to generate passive income.

Read more »

tsx today
Stock Market

TSX Today: What to Watch for in Stocks on Friday, April 4

With broad-based commodity weakness continuing and no resolution in sight on the trade front, the TSX could extend its decline…

Read more »

Canada day banner background design of flag
Tech Stocks

The Top Canadian Stock to Buy With $5,000 in 2025

There are few Canadian stocks out there that offer the outlook of this tech stock, bound for more growth.

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Dividend Stocks

I’d Put $15,000 in These 3 Dividend-Growth Champions for Increasing Income Potential

Want to offset some volatility? Here are three defensive dividend-growth champions that can generate a juicy yield right now.

Read more »

Cannabis business and marijuana industry concept as the shadow of a dollar sign on a group of leaves
Stocks for Beginners

Buy the Dip Before It’s Too Late: This Canadian Stock Won’t Stay Cheap Forever

Investors might think that cannabis stocks are out, but this one could be the top Canadian stock to consider.

Read more »