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How to pick up cheap shares and hold them for long-term profits.
By Tony Luckett
Several weeks ago, whilst shopping in my local supermarket, I noticed that an unusually large number of people had concentrated in a particular part of the store. It turned out that this was due to a promotional offer where goods were on sale at greatly reduced prices; so many more products were being bought than you would normally expect to be sold.
Prices in another market, the stock market, have also fallen sharply in the last couple of months. But many investors, unlike those shoppers, don't like to venture into the stock market after prices have fallen. Instead they prefer to buy only after prices have risen.
Warren Buffett has a few words to say on the subject that may change their minds.
Are shares like hamburgers?
In Berkshire Hathaway's (NYSE: BRK-B.US) 1997 annual report, Buffett suggests that investors should view share prices as if they were hamburgers. Here's the full extract:
"A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."
Prospective purchasers of shares should thus view falling stock markets as an opportunity. After all, you'd buy more hamburgers if their price dropped, so why not look at shares in the same way?
Contradictory thoughts
Many prospective investors discover that they can't cope with falling share prices in the same way that Buffett does. The problem is that because they already own shares they are caught between two contradictory viewpoints; they want higher prices for their existing shareholdings but would prefer to see lower prices for the shares that they want to buy.
It's very difficult to separate the two; though this can be learnt over time, particularly if you are prepared to take a long-term view and therefore don't react to every twitch of the stock market.
Fear and greed
Another of Buffett's sayings concerning falling stock markets is that you should "be fearful when others are greedy and greedy when others are fearful."
In the short term, stock markets are all too often driven by fear or greed, and at the moment fear is the dominant emotion. At times like these, it's a good idea to consider Benjamin Graham's tale of Mr. Market, where he portrays the stock market as a manic-depressive individual who will occasionally offer to sell you his shares at a ridiculously low price, because he has become so pessimistic about the future.
When Mr. Market panics and drives share prices to below a reasonable level, why not take advantage of his prices rather than his wisdom?
Buy high, sell low?
Many investors won't buy shares after prices have fallen. That's because a falling share price is often a symptom of problems within the company, as well as political and economic worries and/or the result of increased competition. So even though Mr. Market routinely causes prices to overshoot on the downside, they worry that he might be right this time.
Private investors as a whole, especially in times of extreme fear and greed, tend to treat shares as if they were Veblen goods. When it comes to Veblen goods, you can throw out most of what you know about the conventional law of supply and demand; if the price of a Veblen good increases then the demand for it will also increase. Similarly when the price falls people won't buy as much and are also far more likely to sell those Veblen goods which they already own.
This is the total opposite of how consumers make their conventional purchasing decisions. No rational consumer would react to the doubling of the price of ice cream by deciding to buy five times as much as they would normally do, unless they feared that every ice cream producer was going to be shut down, which would result in a shortage.
Nor would anyone stop buying potatoes because the price had fallen by 50%, unless they felt that the price had fallen because something was wrong with this particular batch of potatoes. Yet this is exactly what many people do when it comes to the stock market; they treat shares as Veblen goods because they buy more after prices have risen and less after prices have fallen.
This is the major reason why private investors as a whole have historically tended to buy high and sell low, and why massive amounts of private investor selling are traditionally seen as a buying signal.
Bargain hunters need a strong nerve
Investors are very easily put off from buying shares after market falls because they fear that prices will continue to plunge. In times of extreme market volatility like we're currently experiencing it's very common for your new purchases to continue to fall. This comes with the territory and investors have to learn to live with it because no-one can spot the bottom of the market all of the time.
But it's when Mr. Market assumes the worst that he throws up bargains for those of us who are prepared to risk buyers' remorse and have set aside some cash for bargain hunting.
Source:Published in Investing on 26 September 2011
http://www.fool.co.uk/news/investing/2011/09/26/buffetts-2-rules-for-bargain-hunting.aspx
By Tony Luckett
Several weeks ago, whilst shopping in my local supermarket, I noticed that an unusually large number of people had concentrated in a particular part of the store. It turned out that this was due to a promotional offer where goods were on sale at greatly reduced prices; so many more products were being bought than you would normally expect to be sold.
Prices in another market, the stock market, have also fallen sharply in the last couple of months. But many investors, unlike those shoppers, don't like to venture into the stock market after prices have fallen. Instead they prefer to buy only after prices have risen.
Warren Buffett has a few words to say on the subject that may change their minds.
Are shares like hamburgers?
In Berkshire Hathaway's (NYSE: BRK-B.US) 1997 annual report, Buffett suggests that investors should view share prices as if they were hamburgers. Here's the full extract:
"A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."
Prospective purchasers of shares should thus view falling stock markets as an opportunity. After all, you'd buy more hamburgers if their price dropped, so why not look at shares in the same way?
Contradictory thoughts
Many prospective investors discover that they can't cope with falling share prices in the same way that Buffett does. The problem is that because they already own shares they are caught between two contradictory viewpoints; they want higher prices for their existing shareholdings but would prefer to see lower prices for the shares that they want to buy.
It's very difficult to separate the two; though this can be learnt over time, particularly if you are prepared to take a long-term view and therefore don't react to every twitch of the stock market.
Fear and greed
Another of Buffett's sayings concerning falling stock markets is that you should "be fearful when others are greedy and greedy when others are fearful."
In the short term, stock markets are all too often driven by fear or greed, and at the moment fear is the dominant emotion. At times like these, it's a good idea to consider Benjamin Graham's tale of Mr. Market, where he portrays the stock market as a manic-depressive individual who will occasionally offer to sell you his shares at a ridiculously low price, because he has become so pessimistic about the future.
When Mr. Market panics and drives share prices to below a reasonable level, why not take advantage of his prices rather than his wisdom?
Buy high, sell low?
Many investors won't buy shares after prices have fallen. That's because a falling share price is often a symptom of problems within the company, as well as political and economic worries and/or the result of increased competition. So even though Mr. Market routinely causes prices to overshoot on the downside, they worry that he might be right this time.
Private investors as a whole, especially in times of extreme fear and greed, tend to treat shares as if they were Veblen goods. When it comes to Veblen goods, you can throw out most of what you know about the conventional law of supply and demand; if the price of a Veblen good increases then the demand for it will also increase. Similarly when the price falls people won't buy as much and are also far more likely to sell those Veblen goods which they already own.
This is the total opposite of how consumers make their conventional purchasing decisions. No rational consumer would react to the doubling of the price of ice cream by deciding to buy five times as much as they would normally do, unless they feared that every ice cream producer was going to be shut down, which would result in a shortage.
Nor would anyone stop buying potatoes because the price had fallen by 50%, unless they felt that the price had fallen because something was wrong with this particular batch of potatoes. Yet this is exactly what many people do when it comes to the stock market; they treat shares as Veblen goods because they buy more after prices have risen and less after prices have fallen.
This is the major reason why private investors as a whole have historically tended to buy high and sell low, and why massive amounts of private investor selling are traditionally seen as a buying signal.
Bargain hunters need a strong nerve
Investors are very easily put off from buying shares after market falls because they fear that prices will continue to plunge. In times of extreme market volatility like we're currently experiencing it's very common for your new purchases to continue to fall. This comes with the territory and investors have to learn to live with it because no-one can spot the bottom of the market all of the time.
But it's when Mr. Market assumes the worst that he throws up bargains for those of us who are prepared to risk buyers' remorse and have set aside some cash for bargain hunting.
Source:Published in Investing on 26 September 2011
http://www.fool.co.uk/news/investing/2011/09/26/buffetts-2-rules-for-bargain-hunting.aspx
