The stock market rout that started in late September has left many investors frazzled. For some, it is the first real sell-off ever experienced, while for others, years have passed since witnessing such volatility.
My long-time friend sent these two sentences directly to me today on Facebook Messenger: “This is depressing with the market. I’m taking chips off the table.” How would you expect a devout value investor to react to such a statement? Let’s call my friend “George”. Well first of all, George probably isn’t the only one feeling uncomfortable and considering selling at this time. Understandably, few would be ecstatic to log in to their trading accounts and see that their liquid net worth has dropped over the past two months. In fact, I would bet that a large portion of investors in the market have had thoughts about reducing their exposure to equities since the sell-off began. Other than advising George that he should also consider this environment as a possible buying opportunity, I sent him this image:
We all idolize Warren Buffett so much as an investor, but how about Spock? There are few better investing role models I can think of than our fellow half-Vulcan; our long term returns stand to benefit by emulating his qualities. This is no joke. He had the exact temperament needed to be a world class value investor.
What would Spock have to say about the markets if he had the opportunity to comment? Let’s channel him and his replies to the following common thoughts:
“I’m scared… I want to sell”: That is illogical. What is causing this discomfort? If the price is now much lower and the earnings outlook is unchanged, you are being offered a higher earnings yield. If you are anticipating a recession, how sensitive would the earnings of the company in question be to an economic downturn? What exactly has changed in the company’s prospects since you bought the shares?
“Some of the internet stocks have fallen 35%-40% from their 52-week highs. That means they must a bargain.” You may be on the right track in seeking value in companies whose prices have fallen. However, concluding that a stock is on sale solely based on a large percentage drop is insufficient and potentially dangerous. Let’s say you weren’t able to look at Company A’s share price, and based on your research, you would value the stock at no more than $15 (or a P/E of 15x applied against earnings per share of $1). Now you see the share price has fallen 40% recently from $100 to $60. Is it a compelling buy? Definitely not, you would think. How can it make sense in any situation to pay four times the fair value of a company? But the person who didn’t consider any financial information at all may have pulled the trigger. The bottom line is that when a stock becomes overvalued, a steep drop in its price does not necessarily create a great investment.
Remember to always examine your own thought process when investing in stocks. The ease with which we can buy in and sell out of positions can be used to our benefit, but without some calculation and self-control, it often results in hasty decisions. I’m not encouraging investors to only look at numbers, but rather to remove as much emotion out of decisions as possible. This can be accomplished by having a system and using a basic checklist to improve consistency over the long term. Be objective. Be like Spock – not in your social life, but yes, imitate his manner in your investing life. Live long and prosper.
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