Why You Should Buy Companies Nobody Wants

Back in the 1970s, Mike Milken created a new asset class: “junk bonds.” They were high-risk, high-reward bonds. 

Junk bonds had high risk because they were issued by companies that were the most likely to default. But they also had high rewards because investors earned high interest rates to compensate them for the risk. 

But Milken ran into a slight problem. No one wanted to invest in his junk bond fund. Junk bonds were a little too risky. 

One rating agency said that junk bonds “fail[ed] to possess the characteristics of a desirable investment” due to the high levels of risk. Standard and Poor’s even classified these bonds as “non-investment grade” because they were so risky. 

But there was one exception: Howard Marks. Howard Marks thought that AAA bonds (the safest bonds) were bad investments, whereas junk bonds (the riskiest bonds) were good investments. 

He said: “There is only one way AAA bonds can go. AAA bonds are bonds that everybody thinks are great. They are companies making a lot of money, and they have prudent balance sheets. The outlook is good. Everything is perfect. So, if everything is perfect, that means it can’t get better. And if it can’t get better, that means it can only get worse . . . [But] if you buy the bonds of B-rated companies—about which there are such low expectations—maybe it’s easy for there to be a favorable surprise.”

So Howard Marks invested in Mike Milken’s junk bond fund. But that’s not all. Years later, he thought the junk bond market was so promising that he founded his own investment firm focused on junk bond investing: Oaktree Capital. Since its inception, the fund has earned 19% returns per year in its distressed debt funds, making him one of the greatest investors of all time. And today, Oaktree Capital remains as “the largest distressed debt investor in the world,” according to The Economist. 

Howard Marks teaches us an important lesson on investing: You want to invest in assets that nobody expects to perform well because these assets will likely have a favorable surprise.

Look at some investments made by Warren Buffett. You’ll notice that many of his best trades were made when nobody else wanted to own the company. 

Buffett bought $5 billion of Goldman Sachs when no one wanted to own banks during 2008. 

Buffett bought $38 billion of Apple when no one wanted to own the company due to slowing iPhone sales, but it became one of his best investments of recent years.

Buffett bought $24.5 million of Geico in the late 1970s when no one wanted to own auto insurers because the industry’s profitability evaporated, but it became one of his best investments of all time. 

When nobody wants to own a company for whatever reason—pandemics, bankruptcy risk, collapsing economic— expectations will be at their lowest. 

These are the moments when you can make easy money. These are the moments when it’s time to buy.

The opposite also holds true.

The worst time to buy a stock is when everyone wants to own it.

In 2020, Wall Street developed high expectations about Nikola’s future. One investor predicted that it would become one of the leaders in the entire electric vehicle space. Another investor predicted that it posed a major threat to Tesla’s market share. In short, everyone expected it to perform extraordinarily well. However, the company never lived up to those expectations. The stock crashed from $1977 to less than $5 per share, making it one of the worst performing stocks in recent years

Here are two tips to find a stock that nobody wants.

First pay attention to market sentiment. 

Ask yourself, “are people generally optimistic about [insert company’s outlook]? Or are they generally pessimistic? Do people want to invest in this company now? Or are they afraid of investing in this company now?” 

Second, pay attention to price performance. If a company is underperforming the market, it’s a good sign that nobody wants to invest in at. (After all, stock prices go down when nobody wants to invest in a company). So look for companies that meet one of the following three criteria: (1) the stock price is near its 52-week low, (2) the stock price is near its all-time lows, or (3) the stock price has declined significantly in recent years.

Seth Klarman says that the way he screens for stocks that nobody wants is by looking for the worst performers in the past year. He knows that the stocks that nobody wants to touch will have some of the worst performances in the market

In short, buy stocks that nobody wants. This article is an excerpt from Take Stock In This, which people say is the “best book on investing since The Intelligent Investor.” Click here to get a copy of the book today.