Buffett's theory, derived from his professors Graham and Dodds at Columbia in 1951, is that you don't beat the market by speculating but by buying bargain shares (companies selling for less than their inherent worth) and holding onto them as their true value becomes known and reflected in the market price of shares.
Does this work in troubled markets such as today's?
Even more so, say some experts. This is the time to search for bargains as the market is driven by panic, not reason, and good shares are thrown out with bad, meaning priced lower than they're worth by fleeing sellers.
The article from Market Watch, a Wall Street Journal site, is below:
The high price of panic
Dumping stocks now locks in losses and risks missing the market's best days
SAN
FRANCISCO (MarketWatch) -- If you didn't see the market's meltdown
coming, you have plenty of company. If you're selling now, it's
probably too late.
It's not that
stocks can't fall further. You can bet that patience and resolve will
be tested time and again before this bear goes into hibernation.
We haven't seen the
complete capitulation and outright despondency that historically marks
a bottom. Not yet. Main Street consumer confidence is at a 40-year low,
but Wall Street still has too many optimists. A return to early
October's dramatic lows may change their minds. See related story.
But for a longer-term, retirement-focused shareholder -- and that's
most of us -- selling stocks just because they could fall further not
only locks in losses, but also makes it less likely that you'll
participate in powerful market rallies.
Trading Strategies: November 2008
Missing those days can be hazardous to your wealth.
"A lot of the recovery tends to occur in the first few months, and if
you wait until the all-clear sign to get back in, you'll have missed
out on a lot of the gain," said Mark Riepe, head of the Schwab Center
for Financial Research.
Look at what would have
happened if you'd been out of U.S. stocks on the best trading days
between January 1998 and December 2007.
The Standard & Poor's 500 Index (SPX
S&P 500 Index
returned 5.9% annualized over that time, but had you been sidelined for
the decade's 10 biggest days, the yearly gain would have been just
1.1%, a Schwab study shows. Miss the top 20 days and you'd have
suffered a negative 2.6% return; miss the top 40 days and you'd have
lost 8.4% annually. Put another way, staying
invested through thick and thin would have beaten a poor market-timing
effort by more than 14 percentage points a year.
Moreover, market
recoveries typically start strong. The average return for stocks in the
12 months following the end of a bear market is 45%, but if you sat out
the first six months of the rally, that 12-month return becomes just
12%, according to Schwab.
"Trades in reaction to
fear and panic are almost always bad trades," said Kristi Mitchem, a
managing director at Barclays Global Investors.
"It's not a decision you
should enter into without making sure that's really where you want to
go," she added. "Make that shift very intentionally, not with the idea
that you're trading out of equities to get back in when the market
recovers. The likelihood is that you'll miss that recovery."
Bottom fishing
Of course, most of us understand that being out of the market forfeits
potential gains. But with trading volatility in the stratosphere and
stock prices in a downward trend, who's brave enough to catch a falling
knife? We can't all be Warren Buffet.
Or can we? Much has been
made of Buffett and other celebrated value-minded investors going
bargain hunting. Yet Buffett's famous admonition: "Be fearful when
others are greedy and greedy when others are fearful" is easier said
than done -- and for Buffett, at least, probably easier done as well.
Buffett was scorned by
some for a New York Times editorial on Oct. 17 that encouraged
investors to buy U.S. stocks. The criticism recalled the ridicule he
received for a Fortune Magazine article in late 1999 warning investors
to lower their expectations and to beware of a technology-stock bubble.
And let's not forget Buffett's barbed attack on futures and other
speculative derivatives in 2003 as "financial weapons of mass
destruction."
You could lose a lot of
money ignoring Buffett. Instead, take a page from him about what to buy
and sell -- not when.
The key point of the
Times article is that this sage investor isn't turning away from
Treasury bonds because the stars are aligned for stocks. He's buying
because the solid companies on his wish-list are being tossed out with
the junk.
"Investors are right to
be wary of highly leveraged entities or businesses in weak competitive
positions," Buffet wrote. "But fears regarding the long-term prosperity
of the nation's many sound companies make no sense. These businesses
will indeed suffer earnings hiccups, as they always have. But most
major companies will be setting new profit records 5, 10 and 20 years
from now."
What to do
If you must trade, don't trade out -- trade up. In an increasingly
Darwinian market such as this, the fittest companies in defensive
industries will survive in stronger shape.
Think like Buffett and
fill your portfolio with cash-rich, well-run companies that stand to
gain market share in both good times and bad. And if the stock pays a
dividend close to the S&P 500's roughly 3% yield, you're getting
paid nicely for your patience. See related story.
Like Buffett, don't be afraid of being too early to the sale. Jeremy
Grantham, chairman of GMO, the highly regarded Boston-based manager of
mutual funds and hedge funds, is edging into U.S and international
blue-chip stocks. He's buying even though he believes prices have
further to fall, predicting that the S&P 500 will bottom in the 600
to 800 range within two years. (The index closed Friday at 969.)
Retirement-focused
investors would be wise to take advantage of today's market and
diversify, Kristi Mitchem of Barclays Global Investors says. Jonathan
Burton reports. (Oct. 31)
"For an unparalleled 20
years, global equities, especially U.S. equities, have been overpriced.
Now, finally, they are cheap and likely to get cheaper," Grantham wrote
in his most recent quarterly letter to clients.
He added: "We have made our choice: hesitant and careful buying at these prices and lower."
Three sectors that Standard & Poor's recommends in this climate are health care, consumer staples and utilities.
"Staples and health care both tend to hold up relatively well because
you have people saying 'I'm not sure; I want to stick with tried and
true dividend-paying stocks where the earnings transparency is very
great,'" said Sam Stovall, S&P's chief investment strategist.
Richard Bernstein,
Merrill Lynch's chief investment strategist, shares that view. "New
themes are emerging," he wrote in a recent note to clients. "These
themes are higher quality, less credit-sensitive themes such as
developed markets, defensive sectors, and very high quality bonds." See related story.
Hugh Johnson, chief investment officer at money manager Johnson
Illington Advisors LLC in Albany, N.Y., turned cautious on stocks a
year ago. Nowadays his clients are hunkered down in those same
protective sectors: health care, consumer staples and utilities.
"I'm avoiding consumer
cyclicals, financials, industrials, telecommunications, and a little
less so in technology. I have something in all of these sectors, but
not much," he said.
Consumer-goods stocks that Johnson owns include Colgate Palmolive Co. (CL
colgate palmolive co com
Reduce risk
Given the weakening economy and the market's sharp volatility, it's also a good idea to trim areas of a portfolio that are over-concentrated and exposed to unnecessary risk.
Start with company stock. Selling is tough to do when your employer's shares are down, said Mitchem, the Barclays executive. But stock prices are lower across the board, she points out.
"Sell out of your company stock and buy a diversified portfolio," she suggested. "Then you're not going to have a single stock-specific risk that is also tied to your employment."
Investors in target-date and other retirement-pegged mutual-funds should also reassess their tolerance for stocks, Mitchem said.
For instance, if you're invested in a fund for your planned retirement in 2025, but can't stomach the portfolio's hefty allocation to stocks, shift some or all of the money to a more conservative, bond-oriented fund aimed at those who expect to retire in 2010.
"Take a little bit of risk off the table," Mitchem said. "That's not a trade; it's a strategic reallocation."
Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.
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