Stock Valuation and More From Warren Buffett, Part II
Besides considering stock valuation, Warren Buffet thinks a good investor should:
During the stock market collapse in 2008, some investment geniuses were whacked pretty hard. Include David Swenson, the famous head of the Yale Endowment. The Yale Endowment lost over 30% - even though it heavily invested in "alternative" investments like hedge funds that weren't supposed to go down when stocks went down. So what happened?
For one thing, the portfolio held a lot of illiquid investments. An investment is illiquid when you can't easily turn it into cash. The illiquid investments in the Endowment portfolios were typically private equity investments, direct investments and some of their hedge fund investments. Not only did these drop in value, but they couldn't be sold, even if you wanted to sell. There was simply no one willing to buy them.
Buffet holds lots of cash so that he can pounce on opportunities when he spots them. Plus, the stocks he owns are mostly liquid. (Some publicly traded stocks can be a bit illiquid, buy many if not most are pretty liquid all the time. They can be turned into cash almost immediately.) So Buffet's advising us to stay liquid - hold cash and invest mostly in items that you can easily turn into cash.
Let's move on to:
Remember that recent Toyota re-call? Let's say everyone started selling their Toyota's because of that exaggerated "re-call" frenzy that happened a few month's ago. The price of the car's going to go down as more and more people "dump" their cars on the market. Or maybe you no one's buying new Toyotas. (I was hoping people would do this, since I figured I might be able to pick up a Toyota at a really good price. Too bad it didn't happen.)
There are times when stocks fall out of favor. It could be an individual stock or the stock market as a whole, like in 2008. This happens for a lot of different reasons. In fact, after the initial collapse in stocks in 2008, Buffet himself was very publicly telling people it was good time to buy.
The same holds true when people are buying. Buffet's saying be careful when everyone's buying. When lots of people are buying an item, the price goes up. Why would you want to buy then?
It's pretty good advice - buying when others are selling and holding off on buying when lots of others are buying. The thing about it is that it's not so easy to do.
In late 2008, early 2009, the stock market fell farther and faster than it ever had before. People were scared. When everyone around you is fearful, it takes a lot of guts to go against the prevailing mood. You can feel the fear, and the fear makes you freeze. The last thing you'll want to do is buy stocks after they've collapsed and everyone's wondering if they'll fall even more - or even if the whole world is "coming to an end."
How do you overcome this? How do you buy when everyone is selling? It's part fortitude, but it's also part smarts.
You've got to be able to deal with the fearful emotions around you, maybe even your own fearful emotions. But more important, I think, is you need some frame of reference that tells you it's a good time to buy. Frankly, I'd be a bit careful about buying just because others are selling. You need some reason to believe that you're getting good value for you money. So you've got to know something about valuation.
The point is, if you do know that you can scoop up deals while everyone's selling, you'll still need to face the emotional issue - the fear.
On the other hand, don't make this a kind of test of "manhood." It's not a "macho" thing to buy stocks when others are selling. Keep your wits about you.
(What's the equivalent expression if you're a woman? Oh, that's right. Most women don't fall for the "macho" nonsense. That's why they're better investors a lot of the time.)
In the next post, we'll continue with Buffet's next two bits of wise investing advice:
- Stay liquid.
- Buy when everyone else is selling.
- Don't buy when everyone else is buying.
- Value, value, value.
- Don't get suckered in by big growth stories.
- Understand what you own.
- Defense beats offense.
During the stock market collapse in 2008, some investment geniuses were whacked pretty hard. Include David Swenson, the famous head of the Yale Endowment. The Yale Endowment lost over 30% - even though it heavily invested in "alternative" investments like hedge funds that weren't supposed to go down when stocks went down. So what happened?
For one thing, the portfolio held a lot of illiquid investments. An investment is illiquid when you can't easily turn it into cash. The illiquid investments in the Endowment portfolios were typically private equity investments, direct investments and some of their hedge fund investments. Not only did these drop in value, but they couldn't be sold, even if you wanted to sell. There was simply no one willing to buy them.
Buffet holds lots of cash so that he can pounce on opportunities when he spots them. Plus, the stocks he owns are mostly liquid. (Some publicly traded stocks can be a bit illiquid, buy many if not most are pretty liquid all the time. They can be turned into cash almost immediately.) So Buffet's advising us to stay liquid - hold cash and invest mostly in items that you can easily turn into cash.
Let's move on to:
- Buy when everyone else is selling.
- Don't buy when everyone else is buying.
Remember that recent Toyota re-call? Let's say everyone started selling their Toyota's because of that exaggerated "re-call" frenzy that happened a few month's ago. The price of the car's going to go down as more and more people "dump" their cars on the market. Or maybe you no one's buying new Toyotas. (I was hoping people would do this, since I figured I might be able to pick up a Toyota at a really good price. Too bad it didn't happen.)
There are times when stocks fall out of favor. It could be an individual stock or the stock market as a whole, like in 2008. This happens for a lot of different reasons. In fact, after the initial collapse in stocks in 2008, Buffet himself was very publicly telling people it was good time to buy.
The same holds true when people are buying. Buffet's saying be careful when everyone's buying. When lots of people are buying an item, the price goes up. Why would you want to buy then?
It's pretty good advice - buying when others are selling and holding off on buying when lots of others are buying. The thing about it is that it's not so easy to do.
In late 2008, early 2009, the stock market fell farther and faster than it ever had before. People were scared. When everyone around you is fearful, it takes a lot of guts to go against the prevailing mood. You can feel the fear, and the fear makes you freeze. The last thing you'll want to do is buy stocks after they've collapsed and everyone's wondering if they'll fall even more - or even if the whole world is "coming to an end."
How do you overcome this? How do you buy when everyone is selling? It's part fortitude, but it's also part smarts.
You've got to be able to deal with the fearful emotions around you, maybe even your own fearful emotions. But more important, I think, is you need some frame of reference that tells you it's a good time to buy. Frankly, I'd be a bit careful about buying just because others are selling. You need some reason to believe that you're getting good value for you money. So you've got to know something about valuation.
The point is, if you do know that you can scoop up deals while everyone's selling, you'll still need to face the emotional issue - the fear.
On the other hand, don't make this a kind of test of "manhood." It's not a "macho" thing to buy stocks when others are selling. Keep your wits about you.
(What's the equivalent expression if you're a woman? Oh, that's right. Most women don't fall for the "macho" nonsense. That's why they're better investors a lot of the time.)
In the next post, we'll continue with Buffet's next two bits of wise investing advice:
- Value, value, value.
- Don't get suckered in by big growth stories.
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