Tuesday, January 15, 2013

Buffett On A Depressed Stock Market

From the Berkshire Hathaway (BRKa) owner's manual:

"...a depressed stock market is likely to present us with significant advantages. For one thing, it tends to reduce the prices at which entire companies become available for purchase. Second, a depressed market makes it easier for our insurance companies to buy small pieces of wonderful businesses – including additional pieces of businesses we already own – at attractive prices. And third, some of those same wonderful businesses, such as Coca-Cola, are consistent buyers of their own shares, which means that they, and we, gain from the cheaper prices at which they can buy."

Every now and then I re-read the Berkshire owner's manual.

Bet that sounds like fun. Okay, maybe not, but there's much to be learned from it.

Whenever I do re-read it, I come away thinking how helpful it would be if more public companies had their business principles laid out in such a manner.

So it may not sound like all that much fun but it's only six pages long, it's a pretty quick read, and, at least to me, rather useful.
(It certainly requires less time and effort than a typical Berkshire shareholder letter.)

The excerpt is from number 4 of the 15 principles. Toward the end, there's also a good explanation of intrinsic value.

Well worth reading.

The above is not unlike what Warren Buffett wrote in the 1997 Berkshire Hathaway shareholder letter:

"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."

The typical initial reaction to a stock dropping in price is obviously a rather visceral one. So it takes some work to unlearn such an instinctive response. This may not be an easy thing to do, but it starts with having justifiably high confidence in one's own ability to judge business values consistently well, and the discipline to require an appropriate margin of safety.

Judge value well, buy cheap.

In other words, it's not possible (nor is it wise) to react favorably to a drop in price if the investor has an inflated appraisal of his/her own ability to judge intrinsic business value and they tend to pay too much.

Like many things it's an awareness of limits. Overconfidence and overestimation can be the real destroyer of long-term returns.

Adam

Long position in BRKb established at much lower than recent prices
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