Undervalued, underestimated, unbeatable

Summary: Some stocks stay cheap for a reason. Others are just waiting for someone to notice their worth. The challenge isn’t just finding what’s undervalued—it’s knowing what deserves your trust, your time and your money. In this story, we revisit a timeless approach that blends discipline with discernment. It’s not about chasing stars. It’s about quietly owning them before the world catches on. Value investing sounds simple. Buy what’s cheap, wait and prosper. But in practice, it’s a minefield. Plenty of low P/E stocks lure investors in only to go nowhere. The numbers look inviting, the price seems right, but the business is broken and you end up with a value trap instead. That doesn’t mean cheap stocks should be avoided. Far from it. History shows that low valuation, when paired with the right traits, can beat the market and beat it soundly. The trick lies in knowing which cheap stocks are truly mispriced and which are priced perfectly for mediocrity. This is the art John Neff perfected. The fund manager, who steered the Windsor Fund to market-beating returns for over three decades, didn’t just buy low—he bought low with reason. He sought companies whose modest valuations belied solid earnings potential and the promise of a market rerating. The result was a handsome 13.7 per cent annual return from 1964 to 1995, handily outpacing the S&P 500’s 10.6 per cent. In this story, we borrow from Neff’s playbook. We first build the case for low P/E investing using historical performance. Then, we explore its limitations and show how Neff’s lens, applied with rigour, can help filter the winners from the also-rans. At the end awaits a list of such stocks, filtered through his philosophy and refined by ours. Cheap and cheerful There’s a reason seasoned investors keep returning to low P/E stocks: they’ve historically delivered better long-term returns than their high-flying counterparts. Look at Figure 1. Companies with starting P/Es below 40 have consistently outperformed their more expensive peers in every five-year period from 2014 to 2024. The pattern holds across valuation thresholds. Whether you set the bar at a P/E of 10, 30, or even 50, the story remains the same: companies that traded below these levels outperformed those trading above them. Not just that. The average outperformance—or alpha—rises steadily with the P/E level. Stocks below a P/E of 10 beat those above this level by 4.7 per cent for the tested period, but the outperformance widens to nearly 11 per cent between those below and above 50x P/E (see Figure 2). The higher the valuation, the stronger the case for betting against it. And it’s not just about upside. Lower P/E stocks also tend to fall less during downturns. Barring the Covid crash in 2020, they’ve generally been more resilient in corrections, offering both a performance edge and a margin of safety. So, does that mean you should just buy the cheapest stocks and wait for the market to catch on? Not quite. There’s a catch The above exercise shows solid average outperformance of low P/E stocks. But averages can be deceptive. In this case, they are skewed by a handful of standout winners. For instance, nearly 74 per cent of stocks that traded below 40x in 2014 went on to deliver subpar annual returns of below 10 per cent over the next five years. Overall, over half of these stocks posted such dull returns in four out of six five-year periods that we tested (see Figure 3). What this means is that the outperformance came from a few outliers pulling up the average, while the rest delivered mediocre outcomes. The goal, thus, is to spot these few standouts. And for that, a low P/E alone doesn’t cut it. It needs context. It needs filters. It needs growth. This is where John Neff’s framework comes in: to pick actual low-priced compounders from the bargain bin. Neff’s doctrine: Stocks that are cheap, growing and going places Neff’s genius lay in spotting stocks that were not just undervalued but underappreciated for the growth they held. He looked for ‘cheap’ stocks that had real earnings potential and, crucially, hadn’t yet been recognised by the market—giving way for P/E expansion. Simply put, his idea was to find low-P/E companies that the market could rerate upward as growth played out. Why was re-rating, besides growth, so crucial? Our example, shown in Figure 4, illustrates this clearly. Two companies, same five-year EPS growth (15 per cent), but different entry valuations. Company A, bought at a P/E of 15 and exited at an expanded multiple of 25, delivers an annual return of 27.4 per cent. Company B, bought and sold at a P/E of 50 (no multiple expansion), returns just 15 per cent. The lesson? Growth matched with multiple expansion can turbocharge returns. Data agrees with Neff According to him, the lower the starting valuation, the greater the room for expansion. Our analysis backs his view. In all five-year periods from 2014 to 2024, stocks with entry P/Es below 40 consistently enjoyed stronger P/E expansion (or milder compression) than their expensive counterparts. From 2019 to 2024, their median multiple rose 162 per cent. For the high P/E group, it shrank by 27 per cent (see Figure 5). In essence, low valuation allows breathing room—both for the business to grow and the market to notice. And it’s the twin engine of earnings growth and P/E re-rating that delivers outsized returns. Growth is a necessary companion Remember that low-value investing by itself is no magic bullet. For P/E expansion to kick in, growth must follow. A low valuation means little if the business lacks a future. That’s why it is critical to look beyond numbers to context and business fundamentals. Look for industries with tailwinds, companies with execution ability and markets ripe for formalisation. These are the settings where growth is more likely to materialise, giving re-rating a real chance. The flip side of frugality It’s easy to be tempted by past data. Low P/E stocks outperform, rerate more often and fall less in rough markets. But before rushing to scoop up every ‘cheap’ stock in sight, remember that like all investment strategies, this one has its blind spots. One is that by sticking to only low P/E names, you risk missing early-stage winners in new-age sectors that may be expensive today but could justify it over time. And the most dangerous trap is forgetting some companies deserve their low valuations. Weak moats, poor capital allocation, governance concerns—these are rea

This article was originally published on August 01, 2025.