Value investing is a proven long-term investing strategy that produces above-average results at below-average risk – if engaged in properly. However, there are four primary advantages to investing in undervalued dividend growth stocks that facilitate strong long-term performance while simultaneously lowering risk. The beauty of these advantages is that they provide insights and validations as to why value investing has been such a successful strategy long-term.
Moreover, these four advantages are mathematical realities that can be tested and measured in real-world circumstances. However, since these are advantages related to investing, they are also long-term oriented as a result. This is important because short-term performance can often defy or mask these advantages. Consequently, it is very easy for many to lose sight of the incredible rewards that value investing offers over the longer run.
Once again, and as I have pointed out numerous times in the past, these last concepts speak loudly to the profound significance of Ben Graham’s famous metaphor: “in the short run the market is a voting machine, but in the long run it’s a weighing machine.” True investors understand that sound investing strategies relate to investing in attractive businesses.
Therefore, true investors also recognize that business performance takes time to manifest. Companies only report operating results four times a year, and practically speaking, this is the only time that true investors get real information. More simply stated, investors are looking to participating in the earnings power of the companies they select, and it takes time for companies to generate and grow profits and/or the dividends that come with those profits.
4 Advantages of Investing in Undervalued Dividend Stocks:
The first advantage of investing in undervalued stocks is what I call natural leverage. By this I mean you get a high rate of return expansion without having to take on any debt. This happens because of purchasing a stock when its P/E ratio is unjustifiably low, and therefore, generating excessive future returns because of the P/E ratio moving back into alignment with rational valuations.
Although this is pretty much common sense, investors need to be cognizant of the fact that when a stock valuation is unjustifiably low, a couple of things happen – and both are good. First of all, you buy more shares when valuations are low which generates the opportunity to receive more dividends because dividends are paid on the number of shares you own. Second, the current yields available from investing in the dividend stock are highest when valuation is low. Obviously, this leads to a greater amount of cumulative total dividends over time.
Higher total return
Although this advantage is partially redundant with advantage number 1, there is an additional principle beyond P/E ratio expansion that should be considered. When you buy a company at an unjustifiably low P/E ratio, you’ll end up earning a rate of return greater than the return that the business itself generates on your behalf as a shareholder. You can look at this as supercharging the growth potential of the business you are investing in.
As I illustrate in the video, there’s a big difference between a stock that falls in value from being overvalued versus a stock that falls from fairly valued to undervalued. The latter will recover significantly quicker and more predictably than the former. Consequently, buying undervalued stocks defies conventional thinking that says you must take on greater risk to earn higher rates of return.
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