Investing Danger

Investment Perspective – January 2016

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

This, for Value Investors is more about taking our “eye off the ball” than struggling economies and volatile markets.

Buying into the “noise ” of economic doom and “crashing markets” as a reason to worry, change track, or become defensive may on the surface seem valid, especially when “bumpy news” fist emerges. Remember, humans are “hard wired” to “fight or flight”. Worry is a natural response and a built in protection mechanism – we can’t stop it. Also, humans are herd animals – most feel comfortable doing what the crowd is doing. Successful investors tend not to do that though.

Think about it…how many economic dilemmas have their been over the last 10, 25, 100 years? Each time the media reports billions, trillions of dollars lost. They rarely report those billions, trillions of dollars as they were made. That is because their agenda is quite different to investors.

One thing we can count on is that popular media will be unlikely to report anything about how the sound economics of a business is a powerful advantage for savvy investors. Nor will they often report how lower prices offer good buying when they can sensationalise economic and market pricing swings.

The danger of “catching falling knives”

Catching falling knives is a phrase you may have heard around the market place.

It refers to speculators holding shares whose price are dropping or buying them as they fall.

The idea is that it is considered crazy to be holding onto assets whose price is declining or even crazier to buy those assets after their prices have dropped. This approach of course relates to momentum investors (share brokers and their clients) and share market traders, but less so (much less) to Value Investors. That is because price and value are not always the same thing.

For Value Investors declining prices mean that a quality asset is more favourably priced.

Although we may take a slight loss in trading terms if the price drops below the original buy price when we already own holdings, we have the opportunity to average down and buy more which in turn lowers the average overall buy price.

This is something we as Value Investors can practice with confidence whereas if I was investing through a share broker practicing momentum investing or trading, actually, I would feel scared about it.

The reason is because as Value Investors we invest in the underlying business and are not speculating on the share price. We are unperturbed about the price rising or falling in the short term because we are investing in the underlying business fundamentals that has little to do with day-to-day pricing.

This brings us to a rare and profitable event

The blue line shows the trading price of Berkshire Hathaway A shares. The orange dotted line shows the buy back trigger.

The buy back trigger refers to the trading price of Berkshire Hathaway shares and the multiple to book value (1.2 time book value) that that share price would trigger Berkshire Hathaway to use its cash reserves to buy back its own shares.

Share buy-backs are a good thing. Company managers can use surplus cash to buy their own shares when others sell. They then take those shares off the market, making all remaining shareholders richer – less shares on offer, each worth more.

Apart from 2011, this has happened from memory on only one other occasion in the history of Berkshire Hathaway.

There has been some speculation that as that trigger point is close, Warren Buffett may start buying back more shares in Berkshire Hathaway although I know he would also be looking at other opportunity on the markets as well. Let’s face it, if Berkshire Hathaway’s share price has traded down recently then so too will other good businesses trading on the markets. He will also be looking at them and weighing up his options.

Whatever Warren Buffett and his team decide, BRK-B represents a good buying opportunity at current prices for investors. An opportunity for those to average down if they purchased recently at higher prices (remember it is about acquiring an increasing number of shares in businesses with sound economics – not lamenting the we paid too much the other day! Lower prices mean more favourable buying).

An opportunity too for others to obtain exposure to one of the better businesses available. Nothing like BRK exists in New Zealand or Australia.

The Ball

Markets and economies don’t care about investors. They don’t operate on a quarterly or 12 monthly calendar. They can, at times, be highly irrational.

Successful investors keep their eye on the investment ball. They are focused on their long-term goals; invest using a combination of investment strategy (long term game plan) and make adjustments along the way that are based on that strategy (not short term economic or market sentiment).

In the words of Charlie Munger (Warren Buffett’s partner), they (successful investors) have a long attention span. They don’t lose any time worrying about economies and markets.

They continue to look for sound businesses that they can buy at fair prices (the lower / cheaper the better). Low prices are difficult to find in a happy market. More readily available when uncertainty and fear prevail.

Experience tells us that we are better off not getting distracted by the economic and market noise. Let ’s just keep things simple. Lets focus on our long-term goals, on good businesses and buy them at fair prices.

“People make investing more difficult than it needs to be. The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.“

Warren Buffett