I like it when the stock market plunges. I know it sounds perverse for someone with a substantial equity portfolio. Don’t I know that the value of my portfolio has just gone down??
Well, actually, the value may or may not have gone down. What has gone down is the market price – a totally different thing to value.
Remember, we are investors not speculators. As investors we look not to short-term market movements to make money by timing our purchases just before the market rises and sales just before it falls, but as investors we buy portions of a business, a business that we have some understanding of, a business we have analysed. If that business becomes cheaper to buy, should we be upset?
The price of burgers
Try this analogy: You expect to be a consumer of food for the next decade, right? Would you prefer if, over time, food prices rose or fell? Of course, you would like prices to fall so that you can get more for your pound.
Now another analogy, closer to stock market investing: You have a portfolio of corner shops built up by buying every three months. In each case you did a thorough analysis before buying and subsequently. Logically, you will have estimated of the prospective future cash flows flowing to you; and compared this with your required rate of return on the money you invest.
Now imagine the price of corner shops plunges for reasons unconnected with the corner shop business (fears over Chinese shadow banking blow-up, commodities down, US shares down, European stagnation, Ukraine, Ebola).
Are you upset about your portfolio? – only if you planned to sell in the next few months. So, no then.
Will it stop you buying more shops? – no, they are now cheaper, you can buy more for your pound.
The rational investor
Investors judge value based on the expected cash flow to be received from the asset whether that is corner shops or 1000 shares in BP. They do not judge value by what Mr Market is currently offering to buy or sell at. Mr Market is sometimes overly exuberant given the underlying value and sometimes he is over-pessimistic. Are you to judge the value of your assets by Mr Market’s manic-depressive leanings?
Market prices are useful to us, not as guides to value, but as opportunities for us to exploit. We buy when there is a large margin of safety between our assessment of value and the market price being offered. If there is no large margin available then stay in cash. When the market goes down there is more chance of a margin of safety being created.
Preparation……..discipline……patience….and only then….decisiveness
I keep a watch-list of companies currently too expensive relative to fundamental value. When the price falls to my target range I get excited – falling prices are wonderful.
We have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of faddist, but the friend of the fundamentalist (Warren Buffett, 1994)
Determine value apart from price….progress apart from activity….wealth apart from size. Warren Buffett
Be fearful when others are greedy, and be greedy when others are fearful. Warren Buffett, 2008