Warren Buffett, chairman and chief executive officer of Berkshire Hathaway, listens while playing cards on the sidelines the Berkshire Hathaway annual shareholders meeting in Omaha, Nebraska, on Sunday, May 1, 2016.
Photograph by Daniel Acker — Bloomberg/Getty Images
By Jen Wieczner
August 11, 2016

Investors who loaded up on Valeant Pharmaceuticals stock earlier this week are learning that investing like Warren Buffett also means knowing that the Oracle of Omaha’s sage advice comes with a big asterisk.

After Valeant (vrx) stock lost 90% of its value at its peak a year ago, bargain-hunting investors have been looking for signs that the beleaguered drug company is cheaper than it should be, theoretically setting it up for a big comeback. Schooled on Buffett wisdom—such as the Oracle’s famous stock-picking credo, “Be greedy when others are fearful”—such so-called value investors apparently took heart on Tuesday and sent Valeant’s stock soaring 25% even as the company missed earnings expectations and other investors remained leery.

But those feverish buyers soon got a bitter lesson when Valeant shares came crashing back down more than 10% on Thursday, erasing much of their earlier gains, after a report that the company was under criminal investigation for potential insurance fraud. Federal prosecutors are reportedly probing Valeant’s controversial relationship with pharmacy Philidor Rx, ties the company severed after they were revealed last year.

Some short-sellers betting Valeant would fall also bought the stock to cover their positions this week, according to research firm S3 Partners, a move that might have cost them less if they’d waited. Nonetheless, the stock’s quick reversal serves as a reminder that sometimes investors are right to be scared, and stocks that look cheap can still get cheaper.

Indeed, on paper, Valeant does look like the sort of stock that might intrigue intrepid value investors like Buffett. It trades at less than four times its expected 2016 earnings. By comparison, the S&P 500 trades at nearly 19 times its estimated earnings. The cheapest company in that index, which does not include Canada-based Valeant, is still more expensive than Valeant: Fellow troubled drugmaker Endo International (endp), which trades at five times this year’s earnings. The second cheapest company is General Motors (gm), at 5.4 times earnings.

But some people worry that Valeant is what value investors might call a “value trap,” a deceptively attractive stock, at least by the numbers, that later turns out to be a money pit. Pershing Square hedge fund manager Bill Ackman, now Valeant’s largest shareholder (and a self-proclaimed value investor himself), said he thought the stock was undervalued when he bought into it early last year when it was trading around 14 times estimated earnings. Fast forward a few months and a loss of about $3 billion later on the investment, and Ackman thinks the stock is even more of a bargain, saying recently that he thought Valeant had more room to run than any of his other stocks.

Others aren’t so sure. Buffett, whose stock-picking style has informed the value investing discipline, passed on Valeant stock despite being repeatedly encouraged to buy it—and that was long before the drug company was mired in price-gouging accusations, accounting problems and regulatory investigations. Buffett later said that he saw Valeant’s business model as “deeply flawed” and unsustainable.

Of course, Valeant is no longer the same company it was when Buffett refused to buy it. Since its harrowing fall, Valeant has recently replaced its CEO and management team, pledged fair drug pricing and changed its sales and distribution channels.

On Wall Street, though, and perhaps to the public at large—Valeant has made and easy target for politicians including presidential candidate Hillary Clinton— there’s still a feeling that a leopard cannot change its spots. Wells Fargo senior analyst David Maris has been staunchly bearish on Valeant. He rates the stock “underperform”—Wall Street speak for sell—as he believes it is overvalued even at current depressed prices, citing the risk that investors’ sentiment on the company will sour further if it is accused of fraud or “other impropriety” surfaces. During Valeant’s earnings call Tuesday, Maris asked the company, “Are things really changing or is it just new paint on the same old shed?”

In general, so-called value stocks—often defined as those trading at earnings multiples below the market average or their own historical norms—have tricked a lot of investors in the most recent phase of the current bull market, which has worn on nearly seven and a half years. As the market has risen, stocks selling at a discount have become rarer, and those that still look cheap often come with a lot of hair on them. Just ask the investors who thought energy stocks were a screaming bargain in the fall of 2014—just months before the oil price collapsed. Or the bank stock bulls who noted that the institutions were among the cheapest on the market, and who believed interest rates were about to rise in mid-2015. Goldman Sachs (gs) and Bank of America (bac) shares have each lost nearly 20% in the past year. Then there’s SunEdison (sune), in which Greenlight Capital’s David Einhorn and other hedge fund managers went long; the company filed for bankruptcy in April and now trades at about a dime per share.

Value investing can also backfire in the other direction. A common refrain among Buffett disciples is that they’ll never buy Amazon (amzn) stock because it’s “much too expensive.” But even though Amazon’s valuation reached a pricey 75 times earnings last spring, it has since returned 73% in just a little more than a year.

Although value stocks typically hold up better in times of volatility, this bull market has been exceptionally smooth—up until the last year, that is—and favored high-growth momentum stocks, which tend to have more expensive valuations. While the S&P 500 Value Index has slightly outperformed so far in 2016, amid greater market volatility, it has woefully lagged behind for much of this market cycle. Over the past three years, the S&P 500 Growth Index has returned 38%, literally lapping the S&P 500 Value Index, which only returned half as much, or 19%. The entire S&P 500 also crushed the bargain-bin contingent, returning nearly 29%.

Value investors like Buffett will tell you that such stocks are a better bet over the long term because they provide better returns with less risk. But whether a stock was really a “value” play can only be determined in hindsight, and only time will tell with Valeant. So far, Valeant’s “value” has yet to be proven.

Buffett himself knows the pitfalls of buying stocks at prices that seem too good to be true. That strategy, which he calls “cigar-butt investing,” is what led him to buy Berkshire Hathaway (brk-a), the company he now runs, in the first place—only to watch its then-core business (textile manufacturing) die slowly until he shut it down years later. “Buying the stock at that price was like picking up a discarded cigar butt that had one puff remaining in it,” Buffett recounts in his 2014 letter to Berkshire Hathaway investors. “Though the stub might be ugly and soggy, the puff would be free. Once that momentary pleasure was enjoyed, however, no more could be expected.”

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